Publisher: Obsidian Press
Print Management: Book Lab
Cover & Table Design: Liz Dobrinska
Book Design & Typesetting: Chinook Design, Inc.
2 3 4 5 6 7 8 9 10
Copyright © 2014 by Mike Michalowicz
All rights reserved. Published 2014
ISBN-10: 0981808298
ISBN-13: 978-0981808291
Printed in the United States of America
Disclaimer:
No part of this publication may be reproduced, stored in a retrieval system, or
transmitted in any form or by any means, electronic, mechanical, photocopying,
recording, scanning, or otherwise, except as permitted under Section 107 or 108
of the 1976 United States Copyright Act, without the prior written permission of
the publisher, Obsidian Press.
Limit of Liability/Disclaimer of Warranty:
This book contains the opinions and ideas of its author. It is sold with the
understanding that neither the author nor the publisher, through the publication
of this book, is engaged in rendering financial, legal, consulting, investment or
other professional advice or services. If the reader requires such advice or
services, a competent professional should be consulted. The strategies outlined
in this book may not be suitable for every individual, and are not guaranteed or
warranted to produce any particular results. No warranty is made with respect to
the accuracy or completeness of the information contained herein. Both the
author and publisher specifically disclaim any responsibility for any liability,
loss, or risk, personal or otherwise, which is incurred as a consequence, directly
or indirectly, of the use and application of any of the contents of this book.
PRAISE FOR MIKE MICHALOWICZ
THE PUMPKIN PLAN
“Michalowicz is rapidly becoming one of the most innovative business authors
of our time.”
Rieva Lesonsky, former editorial director for Entrepreneur Magazine
“Every page, every chapter, as I read this book, I asked myself ‘Michael E.
Gerber, how come YOU didn’t think of that?’ Just remarkable. Just absolutely a
remarkable book. Every one of you— entrepreneurs, business owners, read it!
Do it now!”
Michael Gerber, author of The E-Myth
“This book reveals degrees of knowledge and wisdom I have rarely seen in
writing before. If you read only one book this year, let it be The Pumpkin Plan.”
Bob Burg, co-author of The Go-Giver
THE TOILET PAPER ENTREPRENEUR
“the business cult classic”
BusinessWeek
“[Mike Michalowicz is] knowledgeable. He’s practical. He’s brilliantly,
refreshingly funny.”
SmallBizTrends.com
“... if you need a swift kick in the butt to achieve your business dreams, read
on.”
BrazenCareerist.com
“I can say without hesitation that The Toilet Paper Entrepreneur, by Mike
Michalowicz is the first book my Mom ever ran off with before I even had a
chance to browse it.”
Chris Brogan, social media expert and author of The Impact Equation
DEDICATION
To my daughter, Adayla, and her piggy bank.
TABLE OF CONTENTS
PRAISE FOR MIKE MICHALOWICZ
ACKNOWLEDGMENTS
INTRODUCTION
CHAPTER ONE: Taming The Beast
CHAPTER TWO: How Profit First Works
CHAPTER THREE: The Naked Truth
CHAPTER FOUR: Choose Your Own Adventure
CHAPTER FIVE: Day One, Quarter One, Year One and Forever
CHAPTER SIX: Destroying Debt
CHAPTER SEVEN: Found Money
CHAPTER EIGHT: Sticking With It
CHAPTER NINE: Profit First — Advanced Techniques
CHAPTER TEN: Living Profit First
CHAPTER ELEVEN: Where It All Falls Apart
CHAPTER TWELVE: Financial Freedom Is Just a Few Clicks Away
ADDITIONAL BOOKS BY MIKE MICHALOWICZ
ACKNOWLEDGMENTS
They say it takes a small army to write a book. They’re right. My army is
Anjanette Harper.
Anjanette and I challenged each other relentlessly. We laughed. We cried. We
yelled. We decided to give up, because it just couldn’t be done. But finally it
worked—we agreed on a small Mexican place for lunch and that the best thing
to do was to share the nachos with the guacamole on the side. With that settled,
we got to work on this book. Two years later we finished Profit First.
Thank you, Anjanette. You are the yin to my yin (yang is kinda overrated).
Thanks to Zoë Bird (who on earth knew a hyphen, en dash and em dash were
different things? I take that back—you did), Nicki Harper (did you really
proofread this in a barn?), Olaf Nelson (the eyeless black pig wins), Liz
Dobrinska (seriously?!? Did someone just chase us down in a giant factory
because your heel broke off at the welding station, thirty minutes ago, and you
said nothing?), Jackie Pennetta (for booking every flight, hotel, rental car, taxi,
and shipment—with never a single hiccup), Lisa DiMona (for saying “make
them regret it”), and Melanie Ramiro (for helping me share everything I know,
with everyone possible, on every single day available).
There was another elite force operating behind the scenes—similar to the Navy
SEALS, but tougher. I called them the Fab 15. They volunteered to read Profit
First the second I finished the manuscript and had eight days to read the entire
book and give me critical feedback on every single concept in it. This elite team
included: Debbie Horovitch (Social Sparkle & Shine), Gloria Rand (Internet
Marketing Expert), Joey Himelfarb (client advocate and service provider... in
other words a really, really great salesperson), Kim LaCroix (The Inspired
Vacation Journal), Paula Mottshaw (Freelance Creative), Lisa Robin Young
(singer and musician), Bill Walsh (father of Liam, Cecile, and Nicholas), Frank
Bravata (New Millennium Technology Services), Jeff Johnson (Technology
Marketing Toolkit), Jessica Oman (Write Ahead Consulting), Nicole Fende (The
Numbers Whisperer), Edwin Soler (Libreria Berea), Hilary Snow (My Massage
Bliss), Jason Spencer (Spencer Weddings and Entertainment) and, perhaps the
most integral, kind, genuine human being on this planet, Zarik Boghossian. If
you are ever in the LA area, look Zarik up. Try to grab him for a cup of coffee
and some nazook—you will discover the secret to being a shrewd entrepreneur
and the most considerate, kindhearted soul at the same time.
Thank you to all the wonderful folks at creativeLIVE. This book wouldn’t exist
if wasn’t for you.
To my children. . . It’s time for a trip to Busch Gardens (that’s our Disney). To
Krista, I live you.
And my thank yous would not be complete without acknowledging you. My
hat’s off to you, entrepreneur. You are my definition of a superhero, you know,
because you are fighting to bring profitability to yourself, your family, your
employees, your community and our world. Thank you for that. Keep fighting,
superhero!
INTRODUCTION
Profit First = mind blown. Everything I learned about accounting is now out the
door #pumpkinLIVE @MikeMichalowicz @creativeLIVE
—Kali Ann Bauer @AmbientArtPhoto
This book was born in San Francisco. I was at the creativeLIVE studios teaching
business growth strategies from my second book, The Pumpkin Plan. During one
of the event sessions, I explained the basic concept of the Profit First system, the
simple method I developed to ensure that I would have not only a financially
healthy business, but a seriously profitable one.
One of the tools of Profit First is the Instant Assessment, a way to quickly gauge
the real financial health of your business. When I ran the assessment on a
volunteer attendee, the Profit First system clicked for everyone in the room.
All creativeLIVE presentations are also broadcast live online and eight thousand
viewers had tuned in for my event. Tweets and comments started flying in from
all over the world. Because the Instant Assessment is so fast and easy, I wasn’t
totally surprised to see the many comments from online viewers saying that they
had assessed their business right then and there. Entrepreneurs, CEOs,
freelancers, business owners—everyone shared how relieved they were to learn
this simple method. It was as though they had each experienced a sudden, total
clarity, an instant jolt of confidence about the money side of their businesses.
I had shared the four core principles of Profit First and the Instant Assessment in
less than thirty minutes and I saw that people didn’t just understand it, they were
already applying it. When a tweet came from Kali Ann Bauer
@AmbientArtPhoto, I knew the Profit First system hit home. (Kali has since
taken down her Twitter account, but you can check her out at
AmbientArtPhotographynd.com.) Here is the tweet, captured by the
creativeLIVE host:
Profit First = mind blown. Everything I learned about accounting is now out the
door #pumpkinLIVE @MikeMichalowicz @creativeLIVE
But it wasn’t until I met Debbie Horovitch that I understood just how vital it was
that I break down the Profit First system further and make it available to
entrepreneurs all over the world.
After the segment ended, we took a break. The camera and lighting people
hustled to get ready for the next segment. Me? I was pumped! It was amazing to
see this instant evidence showing how powerful Profit First truly is. Not only did
it work for different people with different businesses of different sizes, it worked
instantly. I was thrilled.
When the producer ran toward me, I threw up my hand for a high-five, but she
didn’t see it and went in for a fist bump instead. Then ensued the most awkward
moment in human enthusiasm: when a high-five is met with a fist bump and
quickly turns into a fist-five-handshake. So awkward. But she didn’t even notice.
With her fist in my hand, she blurted, “That was amazing! Comments are still
flying in. Can I use Profit First for my personal life? Be sure to open the next
segment with a recap. Drink some water; your voice is getting a little hoarse.
Take a quick five and then head over to makeup to get some shine off your
forehead. And you can let go of my fist now, Mike.”
The producer ran over to the lighting guys; I grabbed a glass of water, chewed
on my pen and looked around to see if anyone had witnessed the fist-five.
That’s when Debbie Horovitch, the entrepreneur behind the Social, Sparkle &
Shine Agency—a Toronto, California firm that specializes in social media
services—approached me. Debbie said, “Could we put my business through the
assessment?”
“Sure,” I said. “It only takes a minute or two.”
Pen in my mouth, people hustling and bustling all around us, I ran through it
right then and there. It was as if Debbie and I were in a world of our own. I
scrawled her annual revenue number on the board. We ran the percentages.
Debbie looked at the results and started to shake with sobs.
She couldn’t bear to look at where she was, or where the Instant Assessment said
she should be.
“I’ve been a fool,” she said, tears streaming down her face. “Everything I have
done over the last ten years is wrong. I am such a fool. I am a fool. I am a fool.”
Let me admit right now, I’m a co-crier—when people cry I go right there with
them. As soon as Debbie started, my eyes welled up with tears and the pen in my
mouth dropped to the floor. I put my arm around Debbie to try to comfort her.
For ten years, Debbie had put her soul into her business, giving it everything she
had, sacrificing her personal life in order to give her business life, and yet she
didn’t have a dime (or a successful business) to show for it. Of course she knew
the truth of her struggles all along, but she had chosen to dance around that truth
and continue to live in denial.
Putting your nose to the grindstone is a really easy way to cover up for an
unhealthy business. We think, if we can just work harder, longer, better—if we
can just hold out—something good will happen, one day. Something big is just
around the corner, right? Something that can wipe away all of the debt, financial
stress and worry, just like magic. After all, don’t we deserve that? Isn’t that how
the story is supposed to end?
No, my friend, that’s the movies —nothing like what we experience in real life.
When Debbie ran the Instant Assessment, she had to face reality: Her business
was on the verge of death and it was taking her down with it. She kept saying, “I
am a fool; I am a fool.”
Those words tore into me, because I’d been there. I understand exactly how it
feels to face the naked truth about my business, my bank account, my strategies
and my hard-fought success.
My own wake-up call came in the form of my daughter’s piggy bank. My story
goes back before that, though, back to when I began to lose my way—the day I
received a check for $388,000. It was the first of several checks I would receive
for the sale of my second company, a multimillion-dollar computer forensic
investigations business I had co-founded, to a Fortune 500 firm. I had now built
and sold two companies, and that check was all the proof I needed that my
friends and family were right about me: When it came to growing businesses, I
had the Midas touch.
The day I received the check, I bought three cars: a Dodge Viper (my college
fantasy dream car, something I promised I would get for myself “one day” when
I “made it,” aka, the “that-guy-must-have-a-tiny-penis-car”), a Land Rover for
my wife, and a spare—a tricked-out BMW.
I had always believed in frugality, but now I was rich (with an ego to match). I
joined the private club; the one where, the more money you give, the higher they
place your name on the members’ wall. And I rented a house on a remote
Hawaiian island so my wife, my children and I could spend the next three or so
weeks experiencing what our new lifestyle would be like. You know, “how the
other half lives.”
I thought it was time to revel in the money I had created. What I didn’t know
was, I was about to learn the difference between making money (income) and
accumulating money (wealth). These are two very, very different things.
I launched my first business on ambition and air, sleeping in my car or under
conference room tables when visiting clients in order to avoid the cost of hotels.
So imagine the surprised look from my wife, Krista, when I asked the sales guy
at the dealership for “the most expensive Land Rover you have.” Not the best
Land Rover. Not the safest Land Rover. The most expensive Land Rover. He
skipped his way to the manager, doing a giddy hand-clap.
Krista looked at me and said, “Have you lost your mind? Can we really afford
this?”
Full of snark, I said, “Can we afford it? We have more money than God.” I will
never forget the stupidity coming out of my mouth that day; such disgusting
words, such a disgusting ego. Krista was right. I had lost my mind—and, at least
for the moment, my soul.
Yup. That day was the beginning of the end. What I was well on my way to
discovering was, while I knew how to make millions, what I was really, really
proficient at doing was losing millions.
It wasn’t just the lifestyle I bought into that caused my financial downfall. The
trappings of success were a symptom of my arrogance—I believed in my own
mythology. I was King Midas, reinvented. I could do no wrong. And because I
had the golden touch and knew how to build successful businesses, I decided
that investing in a dozen brand-new start-ups was the best way to use my
windfall. After all, it was only a matter of time before my entrepreneurial genius
rubbed off on these promising companies.
Did I care if the founders of these companies knew what they were doing? No—
I had all the answers (read that with massive douchey emphasis). I assumed that
my golden touch would more than compensate for their lack of business
expertise. I hired a team to manage the infrastructure of all of these start-ups—
accounting, marketing, social media, web design. I was sure I had the formula
for success: a promising start-up, the infrastructure and my incredible, superior,
magic touch (more douchey emphasis).
Then, I started writing checks—five thousand to one person, ten thousand to
another, every month more checks, and still more. One time, I cut a check for
fifty thousand dollars to cover expenses for one of these companies. In
retrospect, it was clear that I would not be able to grow all of these companies to
the point where they would eventually become niche authorities, as I had with
my two previous companies. There was never enough revenue to cover the everincreasing mountain of bills.
Because of my massive ego, I didn’t allow the good people who started these
businesses to become true entrepreneurs. They were just my pawns. I ignored the
signs and kept funneling money into my investments, sure that King Midas
would be able to turn it all around.
Within twelve months, all of the companies I invested in, save for one, went
belly-up. When I started writing checks to pay bills for companies that had
already folded, I realized that I was not an angel investor; I was the Angel of
Death.
It was a monumental disaster. Scratch that; I was a monumental disaster. Within
a couple of years, I lost nearly every penny of my hard-earned fortune. Over half
a million in savings gone. A much larger (embarrassingly larger) amount of
investment money gone. Worse, I had no incoming revenue. By February 14th
of 2008, I was down to my last ten thousand dollars.
I will never forget that Valentine’s Day. Not because it was so full of love (even
though it was), but because it was the day I realized that the old adage, “When
you hit rock bottom, the only way to go is up,” is total bullshit. I discovered that
day that, when you hit rock bottom, sometimes you get dragged along the
bottom, scraping your face on every one of those rocks until you’re battered,
bruised and bloodied.
That morning, I got a call at my office from Keith, my accountant. He said,
“Good news, Mike. I got a jump-start on your taxes this year and just finished
your return for 2007. You only owe $28,000.”
I felt a sharp pain in my chest, like a knife stabbing me. I remember thinking, “Is
this what it feels like to have a heart attack?”
I would have to scramble to get the $18,000 I didn’t have, and then figure out
how to cover my mortgage next month plus all of the small recurring and
unexpected expenses that added up to a whole lot of cash.
As Keith wrapped up the call, he said that the bill for his services would arrive
on Monday.
“How much?” I asked. “Two thousand.”
I felt the knife twist. I had $10,000 to my name and bills totaling three times that
amount. After I ended the call, I put my head on my desk and cried. I had gone
so far astray from my values, from who I was at my core, that I had destroyed
everything. Now, not only could I not pay my taxes; I had no idea how I would
provide for my family.
At the Michalowicz household, Valentine’s Day is a legit holiday— on a level
with Thanksgiving. We have a special dinner together, exchange cards and go
around the table sharing stories about what we love about each other. This is
why Valentine’s Day is my favorite day of the year. Typically, I would come
home with flowers, or balloons, or both. That Valentine’s Day I came home with
nothing.
Though I tried to hide it, my family knew something was wrong. At the dinner
table, Krista asked me if I was okay. That was all it took for the dam to break.
The shame was too great. I went from offering up forced smiles to sobbing in a
matter of seconds. My children stared at me, shocked and horrified. When I
finally stopped crying enough to speak, I said, “I lost everything. Every single
penny.”
Total. Silence. I slumped over in my chair; the shame was too great for me to
face my family, not when all the money I had earned to support them was gone.
Not only had I failed to provide for my family; my ego had stolen it all away. To
this day I can find no other words to describe it: I felt pure, unadulterated shame
about what I had done.
My daughter, Adayla, who was nine years old at the time, got up from the table
and ran to her bedroom. I couldn’t really blame her—I wanted to run away, too.
The silence continued for two painfully awkward minutes until Adayla walked
back into the room carrying her piggy bank, the one she had received as a gift
when she was born. It had clearly been cared for; even with all those years of
use, there wasn’t a single chip or crack on the bank. She had secured the rubber
stopper in place with a combination of masking tape, duct tape and rubber bands.
Adayla set her piggy bank down on the dining room table and slid it toward me.
Then she said the words that will stay with me until the day I die:
“Daddy, we’re going to make it.”
That Valentine’s Day I woke up feeling like Debbie Horovitch felt after her
Instant Assessment: like a fool. But by the end of the day I learned what net
worth really is, thanks to my nine-year-old daughter. That day I also learned that
no amount of talent, or ingenuity, or passion or skill would change the fact that
cash is still king. I learned that a nine-year-old girl had mastered the essence of
financial security: save your money and block access to it so it doesn’t get stolen
—by you. And I learned that I could tell myself that my natural aptitude for
business, my relentless drive and my solid work ethic could overcome any cash
crisis, but it would be a lie.
Running the Instant Assessment can be like having a bucket of ice water
dropped on your head. Or it can seem like the most humbling moment of your
life, like when your daughter volunteers her life savings to save you from the
mess you made. But no matter how sharp the pain is, it’s better to face it than
continue to live and operate your business in denial.
At creativeLIVE, after Debbie calmed down a bit, I said, “The last ten years
were not wasted. I understand you feel that way right now, but it’s not true. You
needed to experience those years to get you where you are today, here with me,
doing this. You needed to reach a point where enough is enough.” To finally
change, she needed her piggy bank moment. We all do.
The truth is, Debbie is far from a fool. Fools never seek out answers. Fools never
realize there is a different way, even if it’s staring them right in the face. Fools
don’t admit they need to change. Debbie faced the music, realized what she was
doing wasn’t working and decided she would not stand for it anymore. Debbie is
smart and courageous, and a hero, too. She implored me to put her story in this
book and not cloak her name… for you. Debbie wanted you to know you’re not
alone.
The majority of small businesses, and medium businesses, and even some big
ones are barely surviving. That guy driving the new Tesla, whose children go to
private school via chauffeur and who lives in a massive house and runs a three
million-dollar company, is one bad month from declaring bankruptcy. I should
know; he’s my neighbor.
The entrepreneur who says “business is great” at the networking event is the
same woman who later tries to ask me a question in the parking lot that is
indecipherable through her tears; she’s crying because she hasn’t been able to
pay herself a salary for almost a year and will soon be evicted from her home.
That particular incident happened last night, twelve hours before I wrote it down
to become a story for this book. It’s just one of many similar conversations I’ve
had with entrepreneurs who are afraid to tell the truth about their financials.
The Young Entrepreneur of the Year Award recipient who is changing the
world, who is lauded as the next generation of genius, who is destined to be on
the cover of Fortune Magazine because of his business acumen, is taking out
bank loan after bank loan and racking up credit card debt to cover payroll behind
the scenes. I should know; that was me.
There is no elephant in the room. This dirty little secret is bigger than an
elephant—it’s King Kong, people! King Kong is in the room. And today is the
day we call it what is. Today is the day we draw a line in the sand and never
accept it again. Today is the day we make your business (and your life, in the
process) financially strong. Permanently.
I have done it for myself. I have done it with companies I partnered with. And I
have taught countless others how to do this and watched gleefully as their
businesses turned the corner toward profitability.
I promise you, with everything I am, if you follow the system I detail in these
pages, this book will do the same for you. The process is simple. Shockingly
simple, once you know the trick. Sticking to it is the hard part. So I am going to
give you both—how to do it and how to stick with it.
You have probably put a lot of work into growing your business. You are
probably good or great at that part. That’s awesome. And that’s surely half of the
equation. But colossal growth without financial health will still kill your
company. A hot body is useless if its blood is poisoned; money is the lifeblood
of your business. With this book, you have an opportunity to master money.
Money is the foundation. Without enough money, we cannot take our message,
our products or our services to the world. Without enough money, we are slaves
to the businesses we launched. I find this hilarious because, in large part, we
started our businesses because we wanted to be free.
Without enough money, we cannot fully realize our authentic selves. Money
amplifies who we are. There isn’t a single ounce of doubt in my mind that you
are intended to do something big on this planet.
You wear the cape of what I believe is the greatest of all superheroes: The
Entrepreneur. But your superhero powers can only yield as much power as your
energy source provides. Money. You need money, superhero.
When I sat down to evaluate where I went wrong I realized that, while my own
spending and arrogance definitely played a part, I also lacked knowledge. I had
mastered how to grow businesses quickly, yet I never really graduated to
understanding profitability. I had learned how to collect money, for sure, but I
had never learned how to keep it, how to control it or how to grow it.
I knew how to grow a business from nothing, working with whatever resources I
had; but as revenue increased, so did my spending. I discovered that this was the
way I ran both my personal life and my business. I took pride in making magic
happen with pennies in my pocket, but as soon as I got some real cash, I made
sure that I had a very good reason to spend it. It was a check-to-check lifestyle,
but sustainable—as long as sales sustained and did not dip.
While my companies grew explosively, I still operated them on a check-to-check
basis—and I had no idea that this was a problem. The point was to grow, right?
Increase sales and the profit will take care of itself, right?
Wrong. Money problems occur when one of two things happen:
1. Sales slow down. The problem here is obvious—when we operate
check-to -check and sales slow down, we don’t have enough to cover
expenses.
2. Sales speed up. This problem here is not obvious, but it is insidious.
As our income climbs, expenses quickly follow. Consistent incoming
cash flow is hard to sustain. Big deposits feel great, but are irregular.
Drought periods come quickly and unexpectedly, causing a major gap
in cash flow. And cutting back on expenses is nearly impossible
because our business (and personal) lifestyle is locked in at our new
level. Exchanging the newly leased car for a rust-bucket, laying off
employees because we’re overstaffed, saying no to our partners—all of
this is very hard to do because of the agreements and promises we
made. Cutting expenses becomes impossible because we don’t want to
admit we’ve been wrong in how we’ve been growing our businesses.
So rather than reduce our costs in any meaningful way, we scramble to
cover ridiculously high expenses. We steal from Peter to pay Paul,
hoping for another big payout.
Sound familiar? I thought it might. Over the last five years I’ve connected with
entrepreneurs at every level of growth, and this “top line” (revenue-focused),
check-to-check methodology is more common than you may realize. We assume
that multimillion-dollar companies are turning big profits, but it’s rare to find a
truly profitable business. Most entrepreneurs are just covering their monthly nut
(or worse) and accumulating massive debt.
We think bigger is better, but so often all we get with a bigger business are
bigger problems.
Without an understanding of profitability, every business, no matter how big, no
matter how “successful,” is a house of cards. I made a lot of money with my first
two businesses, but not because I ran a tight fiscal ship. I was just lucky enough
to keep the plates spinning fast enough and the company growing big enough
that someone else was willing to buy it and fix the financial problems.
I sold my first two businesses for a big payout and so did not learn the ultimate
financial lesson until after I invested in a dozen more businesses and the lesson
came in hard. After my house of cards fell, I set out on a mission to find a better
way, a simpler way, a highly effective way to ensure that all businesses,
regardless of size and regardless of their current state of affairs, could end the
check-to- check cycle and become instantly profitable—without chasing the big
payout.
And I found it.
Simply put, the Profit First system flips the accounting formula. To date,
entrepreneurs, CEOS, freelancers, everyone in nearly every type of business has
been using the “sell, pay expenses, and see what’s left over” method of profit
creation. This ingrained belief has us sell first, then pay expenses, and let the
profit take care of itself. Which it rarely does, because the profit is what’s left
over. An afterthought. Profit surely isn’t baked into the daily operations. For
many entrepreneurs profit is only considered after the fact. Sometimes monthly.
Sometimes quarterly. And way too often, annually, when their accountant is
preparing the tax returns.
The old, been-around-forever, profitless formula is:
Sales – Expenses = Profit
The new, Profit First Formula is:
Sales – Profit = Expenses
The math in both formulas is the same. Logically, nothing has changed. But
Profit First speaks to human behavior—it accounts for the regular Joes of the
world, like me, who have a tendency to spend all of whatever is available to us.
So in this regard, with the Profit First flip, everything has changed. Now you
secure your profit first, and run your business on the remaining cash you have
left.
It comes down to this—do you want to treat your profitability like leftovers,
knowing you may only find scraps or an empty plate? Or do you want to get
your full, healthy share right up front? I don’t know about you, but I want to get
my due portion first.
I have taught the Profit First system to small companies and big companies, to
private companies and even public companies. It works for all of them. And it
will work for you.
My commitment to you is that, if you follow the Profit First system, your
business will become permanently profitable from the moment of your next
deposit.
Since I began following the system, I have built two more businesses for myself
that are now growing at a healthy rate, profitable right from the start. And the
one business that managed to survive my Angel-of-Death spending spree? We
implemented Profit First and that business is now not only the leader of its niche;
it also turns a profit every month.
In the pages of this book, you will discover how to make your business
permanently profitable. The Profit First system is simple—as I said, shockingly
so. But don’t confuse simple with easy. Understanding what I am about to reveal
to you will be a no -brainer. Having the discipline to do it and follow through
will be the challenge. I will ready you for both.
Provided you take each action step I recommend, you will have transformed
your business by the end of Chapter 5. Do I want you to read the rest of the
book? Hell yes! In fact, if you want to fully realize your potential as a business
leader and take your business where you know it was meant to go, you need to
read the rest of the book. Consider Chapters 6 through 12 the intermediate and
advanced courses in Profit First, in which you will learn all of the methods,
tactics and tweaks that will ensure your cash cow continues to make your life
easier, happier and more fulfilling. In essence, Chapters 1 through 5 will revive
your business. Chapters 6 through 12 will revive you.
Following the Profit First system will take courage and dedication; it will require
you to set your own ego aside. The payoff is worth it, so worth it.
If you will commit to fixing your business’s financials once and for all, you’ll
never have to pull off a last-minute miracle to cover anything again. You’ll
never have to have your own “piggy bank” moment, as I did, or feel like a fool,
as my friend Debbie did when she first realized the financial reality of her
business.
When you commit to following the simple but powerful Profit First system, you
will finally reap the rewards of entrepreneurship, cashing in on your business—
while still running it—over and over again, like clockwork.
Today is the day you say enough is enough. Whether your business is
experiencing occasional financial stress or total financial horror, today is the day
we fix it. Today is the day your business becomes permanently profitable.
CHAPTER ONE: Taming The Beast
I am Dr. Frankenstein.
Okay, not the Dr. Frankenstein, but I am definitely part of the family. I’m
probably his long lost twin brother, or something. Or maybe an estranged heir to
his (mis)fortune. Maybe you are, too.
If you read Mary Shelley’s classic, Frankenstein, you know exactly what I’m
talking about. The good doctor reanimated life. From mismatched body parts, he
stitched together a living being more monster than man. Of course, his creation
wasn’t a monster at first. No, at first it was a miracle. Dr. Frankenstein brought
to life something that, without his extraordinary idea and exhaustive hard work,
would not exist.
That’s what I did. That’s what you did. We brought something to life that didn’t
exist before we dreamed it up; we created a business out of thin air. Impressive!
Miraculous! Beautiful! Or at least it was, until the monster revealed itself.
Stitching together a business with nothing but a great idea, your unique talents
and whatever few resources you have at hand is most certainly a miracle. And it
feels like one, too. Until the day you realize your business has become a giant,
scary, soul-sucking, cash-eating monster. That’s the day you discover that you,
too, are an esteemed member of the Frankenstein family.
And, just as happened in Shelley’s book, mental and physical torment ensues.
You try to tame the monster, but you can’t. The monster wreaks destruction at
every turn: empty bank accounts, credit card debt, loans and an ever-increasing
list of “must-pay” expenses. He eats up your time, too. You wake up before
sunrise to work, and you’re still at it long after the sun goes down. You work and
work, yet the monster continues to loom. Your relentless work doesn’t free you;
it further drains you. Trying to keep the monster at bay before it destroys your
entire world is exhausting. You suffer sleepless nights, worries about collection
calls—sometimes from your own employees—and a near-constant panic about
how to cover next week’s bills with a few dollars and the lint in your pocket.
What is the only way out we can see? Growth. It is the battle cry of nearly every
entrepreneur and business leader. Grow! Grow! Grow! Bigger sales. Bigger
customers. Bigger investors.
The only problem is, it doesn’t work.
Growth is only half the equation. It is a critical half, but still only half. Have you
ever seen the guys at the gym with the massive arms and heaving chests, the
ones as big as oxen who also have toothpick legs? They’re only working half the
equation and have become unhealthy freaks as a result. Sure, that guy can throw
a monster punch, but God forbid he needs to step into it, or move a little. His
puny legs will give out instantly; he’ll curl up on the floor and cry like a baby.
Most business owners try to grow their way out of their problems, hinging
salvation on the next big sale or customer or investor, but the result is simply a
bigger monster. (And the bigger your company gets, the more anxiety you deal
with. If both are cash-eating monsters, a $300,000 company is much easier to
manage than a $3,000,000 company. I know; I have survived operating both, and
bigger.) This is constant growth without concern for health. And the day that big
sale or customer or investor doesn’t show, you will fall to the ground and curl up
crying like a baby.
If you think operating your business is closer to a horror story than to a fairy
tale, you’re not alone. Since I wrote my first book, The Toilet Paper
Entrepreneur, I’ve met thousands of entrepreneurs; and let me tell you, most are
struggling to tame the beast that is their business. Many companies—even those
that appear to have it all together, even the big guys who seem to dominate their
industries—struggle to stay afloat.
I’ll never forget meeting the owner of a $15,000,000 company who furnished his
house with plastic lawn furniture because he couldn’t afford the real stuff. What
does it say when the leader of a multimillion-dollar company can’t even swing a
trip to Ikea? It would make anyone question his true wealth, and the wealth and
health of his business.
So what’s the solution? How do you not only make it out of this situation alive,
but also build the miracle of a business you originally envisioned, a business that
serves you, a business that provides for you? The solution isn’t a bigger monster.
The solution surely isn’t a second and third monster. The solution isn’t killing
your existing monster, or even hacking it apart and stitching it back together into
a tiny monster. In fact, the solution is shockingly simple and surprisingly
effective.
It begins by working with your natural tendencies, not against them.
CHECK-TO-CHECK AND PANIC-TO-PANIC
Have you ever had the thought that the universe knows exactly how much extra
money you have? A customer pays up on a $ 4000 past-due invoice you wrote
off months ago and later that week your delivery truck breaks down—for good.
Bye-bye, $4000. You land a new client and a wad of cash drops into your lap;
only minutes later you remember that this is a three-payroll month. Oh well, at
least now you’ll almost be able to cover it. Or you get a credit on your credit
card account for an accidental billing (woo hoo, found money!), only to discover
another charge on your credit card for something that you forgot all about.
It’s not the universe that knows how much we have in our bank accounts. It’s us.
We default to managing the cash of our business by doing what I call “bank
balance accounting.”
If you’re like most entrepreneurs, and me, this is how it works: You look at your
bank balance and see a chunk of change. Yippee!
You feel great for about ten minutes, and then decide to pay all the bills that
have been piling up. The balance goes to zero and very quickly you feel that alltoo-familiar tightening in the chest as your throat dries up (or any number of
symptoms of stress).
What do we do when, instead of a decent bank balance, we see that there’s next
to nothing there? We immediately panic a little (or a lot). We hit “go” mode:
need to sell fast! Need to make collection calls! Need to pretend the bills never
arrived, or send out checks and “accidentally” forget to sign them. When we
know our bank balance is super low (I’m talking limbo “how low can you go”low), we’ll do anything to buy the only thing we can afford: time.
I’m going to go out on a limb and guess that you only look at your income
statement on occasion. I suspect you rarely look at your cash flow statements or
balance sheet. And if you do, I doubt you review these docs on a daily basis or
understand exactly what they say. Bet you check your bank account every day,
though? It’s okay. If you look at your bank account daily, I want to congratulate
you, because that means you are a typical—scratch that—a normal business
leader; that’s how most entrepreneurs behave.
It’s human nature to look at what you have right now and make decisions based
on that information. This is called the “Recency Effect,” the psychological
phenomenon in which we humans (that’s you, by the way) place a
disproportionate significance on what we experienced most recently. For
example, if I ask you to recall the last few words I wrote, you will easily recall
this sentence (the most recent), but good luck remembering two sentences ago.
Recent stuff is the big stuff; all the other stuff becomes a waning memory. How
does the Recency Effect apply to your finances? If you deposit lots of money
today, you will probably feel great, the outlook for your business will appear to
be good and all will seem well. That’s the Recency Effect. If, on the other hand,
your bank account is bone dry, you might feel hopeless and your business may
seem like a horrible mess. (Maybe as though it’s a monster?) That’s the Recency
Effect. It is a trap because it dictates our behavior.
Also in our nature as entrepreneurs is the desire to find problems and fix them.
This is how we manage money. When we have enough money in the bank, we
think we don’t have money problems, and so we focus on other challenges.
When we see that we don’t have enough money in the bank, we go on red alert
and take immediate action to fix our money problems, usually by trying to
collect revenue quickly, or sell a big-ticket item or some combination of the two.
We use the money we have to pay the bills we owe; when we don’t have enough
to cover everything, we try to get more money through sales and collections.
Except that to support new revenue, we now have a host of new related
expenses, so the cycle starts all over again. If you haven’t relied on it from the
start, eventually the only “solution” is to take on debt—a second mortgage on
your family home, a line of credit tied to your building, a stack of credit cards
three inches high. This is how many entrepreneurs end up operating their
businesses check-to-check and panic-to-panic.
So let me ask you a question. How easy would it be to grow your business if you
operated this way? Do you think you’d ever be able to get off this roller coaster
ride? Could you dig yourself out of debt using this system? Of course not.
And yet bank balance accounting is human nature. We humans are not big on
change. Change is hard. With your very best intentions, changing your natural
tendencies to operate your business based on how much cash you see in your
account would take years. I don’t know, you tell me—do you have years to make
your own transformation before your very own monster destroys everything? I
sure as hell didn’t.
This is why, if we are to free ourselves from living check-to-check and panic-topanic, we must find a method that works with our nature, not against it.
Without an effective money management system that does not require massive
mindset change, we get stuck in trying to sell our way out of our struggles. Sell
more. Sell faster. Get money any way you can. It is trap—a dangerous trap that
would even have Frankenstein’s monster poopin’ his panties. It’s the Survival
Trap.
THE SURVIVAL TRAP
This is how the Survival Trap works. Take a look at Figure 1 on the next page.
We are at point A (which is really called crisis) and we want to get to point B
(which is our vision for our future). The thing is, our vision is usually very
vague. Instead of a clear statement of our products or services and the clients we
want to serve, it might be something like, “I want a lot of money and some relief
from stress.” The connection between Point A and Point B is never defined,
beyond, “Sell, baby! Just sell!” And “just selling” is a huge part of the trap, for
three reasons:
First, any sale feels like a good sale, because sales help to temporarily lift you
out of crisis. Now look at the figure. You can see that many of the decisions we
make around “just selling” in fact take us farther away from our vision.
Maybe you start offering a new service, or add a new product, because it will
make fast money, but never even consider that it has nothing to do with what
you want your company to become or whom you want your company to serve.
Take for example my lawn guy, Ernie. He, like most lawn guys in the Northeast,
makes tons of money removing leaves. This past fall he knocked on my door and
said that he noticed leaves in my gutters and would gladly clean them up. He has
a captive client (me), and can now sell me another service. Easy money. When
he was on the roof, he noticed my shingles needed repair. He offered roofing
services. Why not repair my chimney, too?
It is very easy to go from being a guy who rakes lawns to a guy who fixes
chimneys because of the opportunity for “easy money” with captive clients. The
money may be easy, but what about the costs to do it all? Rakes and blowers for
yard work are useless when working on roofs or chimneys. Now this guy needs
ladders, roofing gear, bricks and other materials. And most importantly, he needs
the skills to complete the tasks, which means hiring skilled labor or going back
to raking, gutter-cleaning, roofing and chimney school. Each new “easy sale”
took Ernie farther from his vision for his lawn-raking business.
The Survival Trap promises fast wealth, but when we’re caught in it we rarely
think about the massive cost of opportunity; and most of the time, we can’t
discern profitable income from debt-generating income. Instead of being the
world’s best at one thing, mastering the process of delivering perfectly and
super-efficiently, we end up doing a greater variety of things and become less
and less efficient at each step, while our businesses become more and more
costly to run.
The Survival Trap is not about driving toward our vision. It is all about taking
action, any action, to get out of crisis. Any of the actions shown in Figure 1 will
get a us out of an immediate crisis. But, by taking actions like those on the left of
the circle, we get out of crisis, sure enough, but we are going in the opposite
direction from our vision at Point B. Other actions shown on the diagram don’t
take us in the opposite direction, but are askew. Only when you stay in the
channel of the horizontal dotted lines do you make your vision for your business
a reality.
All of the “just sell” actions we take in the moment bring temporary relief. They
get us out of immediate crisis, but when the money dries up again the following
day, and as the expenses grow the following week or month, we find ourselves
in crisis again and the pattern repeats. We take money from anyone (and I mean
anyone) willing to pay us. Money from bad clients. Money for bad projects.
Money from our own pockets (if there’s anything left in them besides two dimes,
a stick of gum and a wad of lint). In this way, we stay stuck on the roller coaster
ride that is surviving check-to-check and panic-to-panic.
Second, the Survival Trap is deceptive because it fools us into thinking we are at
least inching toward our vision. Consider the actions on the right side of the
Figure 1. For instance, a “just sell” approach will, by pure happenstance, also
occasionally move us toward our vision, we can easily trick ourselves into
believing that we’re on the right track. Sometimes we make a crisis decision
without considering our vision or the path to get there and we get it right.
Happenstance happens. At that point we say, “See! I’m getting there. Things are
clicking. Things are coming together.” But this is random chance, resulting from
crisis, not focus or clarity, and therefore false. It is like believing that because
you once won on a scratch-off card, the lottery is a good investment strategy.
And it is this kind of thinking that quickly lands us back in crisis mode.
Last, when we’re stuck in the Survival Trap, we focus our attention on revenue
generation first and foremost. Any client (who pays) is a good client. Any work
(that makes money) is good work. Crisis makes us panic about money. We need
more money now! Never forget: All revenue is not the same. Some revenue
costs you significantly more in time and money; some costs you less. You must
distinguish between the two, since one is profitable and the other puts you out of
business.
I explained the Profit First system to my friend Debra Courtright many years
back. Debra runs DAC Management, a bookkeeping business. (I’ll give you one
guess at her middle initial.) Since the day she integrated the Profit First system,
Debra has saved company after company using these principles, the exact
principles I am about to teach you. Actually, she has more than just saved
companies; she consistently turns business after business into cash cows.
Over the years, we have discussed the effects of Profit First on her clients and
made some tweaks along the way. She has shared many stories, always
removing the names of the guilty. When Debra told me the story I am about to
share with you, my jaw dropped. The story is about someone I’ve never met,
about a business I’ve never visited, but it’s a perfect example of the Survival
Trap, played out.
Debra received an inquiry from Alex, a prospective client. When she called
Debra, Alex was literally gasping for air on the other end of the line. The owner
of a local bistro, Alex did not have enough money in the bank to pay her
employees or vendors, let alone herself. Her accounting was so messed up she
didn’t even know to whom she owed money.
Debra immediately implemented a customized version of Profit First (something
I will teach you to do for yourself in Chapter 4). While setting up a Profit
Account, Owner’s Pay Account, Tax Account and Operating Expenses Account,
she asked Alex where she kept the sales tax records.
Alex looked at her blankly and said, “What do you mean?”
Turns out, Alex had been charging customers seven percent sales tax, but rather
than reporting the earnings and sending the tax to the government, she was using
the money to pay other bills.
Debra explained the consequences. “If you don’t pay the taxes you collect, you
are breaking the law. The state’s tax authority can come in here unannounced,
shut everything down and walk away with every asset you have. Then they will
send you to jail, broke and in debt.”
Alex thought she had time to sort everything out, but the very next week,
Debra’s warning became a reality. The tax reps from the state showed up
unannounced at Alex’s bistro.
They decided to show her mercy. In front of her customers and employees, they
emptied the cash register and handed Alex a letter that basically said, “Pay your
sales taxes immediately, or we will shut you down and send you to jail.” Cue the
next anxiety attack, and Alex’s next breathless call to Debra. And yes, that is the
tax man showing mercy.
The Survival Trap is an ugly beast. It buys you time, but the monster gets bigger
and bigger. And at some point it will destroy you.
Sustained profitability depends on efficiency. You can’t become efficient in
crisis. In crisis, we justify making money at any cost, right now, even if it means
skipping taxes or selling our souls. In crises, the Survival Trap becomes our
modus operandi—until our survival strategies create a new, more devastating
crisis that scares us straight, as it did Alex, or, more commonly, scares us right
out of business.
Part of the problem is bank balance accounting—looking at the money in your
bank account as one pool from which you can operate your business without first
addressing tax issues or your own salary, never mind profit. This leads to top
line thinking—focusing on revenue first, last, and always. That thinking is
supported by the traditional accounting method public companies must use and
most small businesses elect to use: GAAP (Generally Accepted Accounting
Principles).
GAAP IS KILLING YOUR BUSINESS
Since the dawn of time—or shortly thereafter—businesses have kept track of
their earnings and expenditures using essentially the same method:
Sales – Expenses = Profit
If you manage the numbers like most entrepreneurs, you start with sales (the top
line) and then subtract costs directly related to the delivery of your offering
(product or service). Then you subtract all the other costs you incur to run your
business: rent, utilities, office supplies and other administrative expenses, sales
commissions, taking your client out to lunch, signage, insurance, etc., etc. Then
you pay taxes. Then, and only then, do you take your owner’s distribution
(owner’s salary, profit distribution, etc.).
Let’s be honest, entrepreneurs hardly ever take anything close to a real salary,
and good luck telling the government that you decided to skip taxes this year so
that you could pay yourself. Finally, after all that, you post your company’s
profit. And if your experience is like the majority of entrepreneurs, you never get
to “finally.” When you’re waiting for the leftovers, at best you’ll get scraps.
This method ultimately became formalized in the early 1900s. The particulars
are updated regularly, but the core system remains the same. Start with sales.
Subtract direct costs (the costs you directly incur to create and deliver your
product or service). Pay employees. Subtract indirect costs. Pay taxes. Pay
owners (owner distributions). Retain or distribute profit (the bottom line). Even
if you outsource your bookkeeping or keep a shoebox of receipts under your bed,
you know the basic idea.
Logically, GAAP makes complete sense. It suggests that we sell as much as we
can, spend as little as we can and pocket the difference. But humans aren’t
logical. (One episode of Bridezilla pretty much proves that.) Just because GAAP
makes logical sense doesn’t mean it makes “human sense.” GAAP both
supersedes our natural behavior and makes us believe bigger is better. So we try
to sell more. We try, and try, and try to sell our way to success. We do
everything we can to make the top line (revenue) grow so that something,
anything, will drip down to the bottom line. It becomes a relentless cycle of
chasing after every shiny object disguised as opportunity (that’s “little
pumpkins” to my peeps—you know who you are).
Throughout this haphazard, often desperate, growth process, our expenses are
lost in the wash—we just pay as we go. They’re all necessary, right? Or at least
we think so. Who knows? We’re too busy hunting down sales and trying to
deliver on all of our promises to worry about the impact of expenses!
We try to spend less without considering investments versus costs. We don’t
think about leveraging our spending to get way more mileage out of way less.
We can’t. The more variety of stuff we sell, the more our cost of doing
businesses rises. We need to spend more to grow. They say it takes money to
make money. But how come no one ever told us what that really translates to: It
takes more money to make less money.
As our monster gets bigger, the need to feed the beast gets out of hand. Now
we’re faced with covering expenses for more employees, more stuff, more
everything. The monster grows. And grows. And grows. Meanwhile, we’re still
dealing with the same problems, just bigger: more empty bank accounts, higher
stacks of credit card bills, bigger loans and an ever-increasing list of “must-pay”
expenses. Sound familiar, Dr. Frankenstein?
GAAP’s fundamental flaw is, it goes against human nature. No matter how
much income we generate, we will always find a way to spend it—all of it. And
we have good reasons for all of our spending choices. Everything is justified.
Everything is necessary. Soon enough, whatever money we had in the bank
dwindles down to nothing as we struggle to cover every “necessary” expense.
We get caught in the trap of sell-grow-spend, sell-grow-spend.
How do you think Debra’s client Alex ended up in her predicament? Do you
think she said, “It’s a beautiful day today—I think I’ll steal from the
government”? Heck, no. She had convinced herself that she needed the sales tax
income she collected right now, and when “later” came, she wasn’t prepared to
cover it.
A secondary flaw is this: GAAP teaches us to focus on sales and expenses first.
Once again, it works against our human nature, which urges us to grow what we
focus on. Remember the lesson of the Recency Effect; it plays out again with the
focus on sales and expenses. There is a saying: “What gets measured, gets
done.” GAAP has us measure sales first (it is the top line, after all), and therefore
we sell like mad while expenses are treated like a necessary evil to support—
you guessed it—more sales. We spend all that we have, because we believe we
must. And we use terms like “plowback” or “reinvest” to feel good about it.
Profit? Your salary? Mere afterthoughts. Leftovers.
Another problem with GAAP is, it is overwhelmingly complex. You need to hire
an accountant to get it right, and when you ask the accountant the details about
GAAP, he is likely to get confused. The system changes and is up for
interpretation. And we can play games with GAAP: Move some numbers around
and post stuff in different spots and the numbers look different. Just ask Enron—
they were able to post profits as they were going bankrupt. Yuck!
At the end of the day, the start of a new day, and every second in between, cash
is all that counts. It is the lifeblood of your business. Do you have it or not? If
you don’t, you’re in trouble, and if you do, you can sustain.
GAAP was never intended to only manage cash. It is a system for understanding
all the elements of your business. It has three key reports: the income statement,
the cash flow statement and the balance sheet. There is no question that you need
to understand these reports, since they will give you a holistic view of your
company; they are powerful and highly useful tools. But the essence of GAAP
(Sales - Expenses = Profit) is horribly flawed. It is a formula that builds
monsters. It is the Frankenstein Formula.
To successfully run a profitable business, we need a super-simple system to
manage our cash, one we can understand without help from an accountant, one
that is designed for humans, not Spock.
We need a system that can instantly tell us the truth about the health of our
businesses, one that we can look at and know instantly what we need to do to get
healthy; a system that tells us what we can actually spend and what needs to be
reserved; a system that doesn’t require us to change, but automatically works
with our natural behaviors.
Profit First is that system.
•••
The ending of Frankenstein is not happy or nicey-nice. The monster destroys
everything in Dr. Frankenstein’s life—his wife, his family, his hope for the
future—so he sets out to exact revenge and kill his creation. The hunt for the
monster takes a toll on Dr. Frankenstein and he dies a wrecked man, the monster
close behind him. Frankenstein is a scary parallel to the extremes of
entrepreneurship. Monster businesses have killed marriages, torn apart families
and, for some entrepreneurs, decimated any hope for the good life. That miracle
of a business we created can end up causing untold suffering; when that happens,
the hatred Dr. Frankenstein had for his monster is all too often the chief emotion
entrepreneurs have toward their businesses.
But your story doesn’t have to end that way. You can have your happily ever
after. The good news is that, while your business may seem to be a monster
controlling your life, it is also powerful. Whether your annual revenue is
$50,000, $500,000, $5,000,000 or even $50,000,000, your business can become
a profit-generating workhorse.
Never forget the power of your “monster”—you just have to understand how to
direct and control it. When you learn this simple system, your business will no
longer be a monster; it will become an obedient, pasture-loving cash cow. A
damn strong one, at that.
It worked for Alex, the coffee-shop owner who neglected to pay her sales tax
and paid the consequences. Working with Debra, her accountant, and applying
Profit First, Alex has paid off all of her taxes and penalties. It took three years to
recover, but now Alex is current with her taxes and is running a profitable
business. She has fewer employees, but they are fantastic and run the place like
clockwork. Business is humming, and freshly ground coffee is always brewing.
What I am about to share with you is going to make your business profitable
immediately and determinately. I don’t care what size business you have or how
long you have been surviving check-to-check and panic-to-panic, month after
month and year after year. You are about to be profitable. Forevermore. No more
leftovers for you— it’s time for you to eat first.
Here’s the deal. There is only one way to fix your financials: by facing your
financials. You can’t ignore them. You can’t let someone else take care of them.
You need to take charge of the numbers. But there is good news—the process is
really, really easy. In fact, you will fundamentally understand it, and implement
it, within just a few more chapters.
ACTION STEPS
GET YOUR HEAD IN THE GAME
Step 1: Draw the line in the sand. Agree that, as of today, you are turning over a
new leaf. Commit to yourself, and to me, that you will run a profitable business
and make everything else secondary to that goal. Email me (my contact info is
on my website, and I do read my own email) and decree that you are drawing a
line in the sand. Today is the day your business becomes healthy. Permanently.
Don’t wait another second.
Step 2: Agree not to beat yourself up. I don’t care what your business financials
look like today. I don’t care if your business is on the verge of going under, or if
you just want to ramp up your profits even higher. Every business can be
improved with Profit First. The only thing that will get in our way is if you bitch,
moan and cry about the past. So that will not be permitted. I am granting you a
clean slate. And you are promising me that you aren’t going to complain about
the past. Together, we are just going to get to work and fix it.
CHAPTER TWO: How Profit First Works
It’s funny how losing nearly all of your money can cause you to watch a lot of
late-night network TV. What? Before you side-eye me, this was right after I lost
all of my money to my own arrogance, so cable TV was the first thing to go.
Insomnia brought about by anxiety does not equal better quality sleep, so that
pretty much left me with two options: Stare at the ceiling or watch late-night
network TV, courtesy of my twelve-dollar, indoor rabbit-ear antenna (yes,
antennae still work and, even with the fancy modern digital signal, the reception
still sucks).
Most infomercials pitch instant cures. Eat only grapefruit for ten weeks, and
presto! You’re thin. Drink this magic goo three times a day and before you know
it you’ll be able to bounce a quarter off your ripped abs! Wrap this
electromagnetic thingamajig around your waist, electrocute yourself every five
seconds, and you’ll have a teeny-tiny waist in less than six weeks, all while
never getting off the couch to clean the Doritos off your shirt!
One late night, I had had enough of the infomercials and turned on PBS to find,
sure enough, a fitness guy talking about diets. (Was God trying to tell me
something? I stopped working out for a little bit, but. . . jeez!)
The fitness expert explained to the studio audience that the quick fixes lauded by
late-night infomercials didn’t work (thank you!) and that they weren’t
sustainable. He said that what we really need are simple lifestyle fixes that do not
require us to change our natural tendencies, changes that make an impact before
we have a chance to screw it up with our unhealthy food choices. And his first fi
x suggestion? Smaller plates.
Now riveted, I watched as the man explained that our natural human behavior is
to fill our plates with food and, because Mom said so, clean that plate right up by
eating everything on it. I still don’t get Mom’s logic—there are children starving
in Africa, so I need to get fat? But the “clean-your-plate club” was instilled in
me and probably in you, too. The message is ingrained. Changing that habit for a
day is a no-brainer. But changing it permanently? That’s hard. Some would say
it’s nearly impossible. This is why so many people who diet gain the weight
back, why people rarely follow through on New Year’s resolutions past the end
of January, and why it’s so difficult to be disciplined with your spending.
As I continued to watch the program, the expert went on to say that rather than
work to change our “eat everything on the plate” behavior we simply need to
change the size of our plates. When we use smaller plates, we dish out smaller
portions, thus eating fewer calories while continuing our natural human behavior
of serving a full plate and eating all of what is served.
I sat straight up on the couch, my mind alert with this new revelation. The
solution is not to try to change our ingrained habits, which is really hard to pull
off and nearly impossible to sustain; but instead to change the structure around
us and leverage those habits.
It was then that I realized: Every penny my company made was going onto one
plate, and I was gobbling it all up, using every last scrap to operate my business.
Every dollar that came in went into one account, my operating account, and I
was “eating it all.”
It hurts to admit this, but I was never good at money management. I thought I
was, but looking back now, I realize how bad I was at managing money. I
thought I was frugal in principle, or because I was a savvy entrepreneur. But in
truth, I was frugal in my businesses because it was forced upon me.
When I started my first company, a computer network integrator (today it would
be called a managed service provider), I had no money. I was able to sell,
service, run my office—I could do all that stuff with practically no money
because I didn’t have any. As the business grew, I started to spend. The more I
made, the more I spent, and I believed that all expenditures were necessary. We
needed better equipment, a better office (an unfinished basement is no place for
a business). I brought on people to do the work so I could sell more. Every step
forward in sales growth required an equal step up in my infrastructure, human
resources, grade-A office space or whatever (all fancy terms for expenses).
After losing it all, I discovered that I work with whatever is put in front of me.
Give me a hundred dollars and I will make it happen. Give me a hundred grand
and I will make it happen. And while a hundred thousand-dollars made it easier
to make it happen, it also made it way easier to make mistakes. Totally waste a
few hundred dollars when you have a hundred thousand at your disposal, and
you feel nothing. Totally waste a few hundred bucks, when you only have a few
hundo to your name, and you feel that pain fast and hard.
Looking back at my companies, I realized that I grew them quickly but still
survived check-to-check, only making the real money when I sold them. As my
incoming cash increased (the darker line on Figure 2), my expenses increased at
a similar rate (lighter line). The only time I would have a profit was when
income jumped up and I didn’t have time to spend at the same rate. However, I
would quickly ramp up my expenses to serve my “new level of sales.” Then
sales would settle back down, or drop, while my new level of expenses remained
higher. Losses accumulated. The desperate need to sell more, faster, increased.
I muted the television and began to connect the dots. I wondered, “If I reduce the
‘plate size’ of my business’s operating account, will I spend differently?”
Looking back at my past behavior, the answer came quickly. Yes, I would. So
rather than try to curb my spending habit, I would create the experience of
having less cash on hand than I actually had. How did I know this would work?
Because it already works for millions of people, with every paycheck—think
401K deductions.
Excited, I realized that, as with a 401K, if I were truly going to believe that the
money I had left over in the bank after reducing my deposits from revenue (my
small plate) was all I had to work with, whatever money I took off the top would
have to go into a separate account that would not be easy for me to see, let alone
access. Investment accounts charge penalties for early withdrawals to dissuade
investors from drawing from their accounts, and I needed something similar in
place to stop me from borrowing from the separate account.
But what would I do with the “other money?” Could I use it to— shock of
shocks—pay myself a salary? Pay my taxes?
Hey. Hey wait. Wait one stinkin’ minute. Could I actually set aside some of it
for profit—before I paid bills?
And that’s when it hit me—what if I took my profit first?
For a guy who built two businesses on top line (revenue focused) thinking, this
was a revelation. At 3:00 a.m., it sounded like crazy talk. Who would have the
audacity to take profit first?
Me.
WHAT THE DIET INDUSTRY KNOWS ABOUT GROWING A
HEALTHY BUSINESS
A 2012 report by Koert Van Ittersum and Brian Wansink in the Journal of
Consumer Research identifies the average plate size in America as having grown
23% between the years 1900 and 2012, from 9.6 inches to 11.8 inches. Running
the math, the article explains that, should this increase in plate size encourage an
individual to consume just fifty more calories per day, that person would put on
an extra five pounds of weight… each year. Year after year, that adds up to a
very chunky monkey.
But using smaller plates is just one factor. A Twinkie on a small plate is still a
Twinkie.
There is more to a healthy diet, based on four core principles of weight loss and
nutrition. These four principles are exactly the same foundation for business
health.
1. Use Small Plates – Using smaller plates starts a chain reaction.
When you use a small plate, you get smaller portions, which means
you take in fewer calories. When you take in fewer calories than you
normally would, you start to lose weight.
2. Serve Sequentially – Eat the vegetables, rich in nutrients and
vitamins, first. If you leave them to eat last, you will rarely finish your
vegetables. They’ll just sit there piled up on the side of the plate.
3. Remove Temptation – Remove any temptation from where you
eat. People are driven by convenience. If when you’re hungry, junk
food is easily accessible, you’re more likely to eat it. If you don’t have
any junk food in the house, you’re probably not going to run out to the
store to get it. (That would mean putting on pants.) You’re going to eat
the healthy food you stocked, instead. My weakness is Chocodiles:
Twinkies covered in dark chocolate and wrapped in love. Fortunately,
they stopped making them. But if one sneaked into my house, even if
it had expired in 1972, I would devour that delicious elixir of love and
monounsaturated fats. Now, I always make sure I have healthy options
with me, and the junk is locked away.
4. Enforce a Rhythm – Don’t eat when you’re hungry; it is already
too late, and you will binge. Instead, eat frequently so that you never
get hungry. You will actually consume fewer calories this way.
Profit First is a simple, “small plate” diet philosophy. In the Introduction I
shared the basic formula of Profit First and how it differs from the accounting
method most businesses use.
The old profitas-“leftovers” formula (what I like to call the Frankenstein
Formula):
Sales – Expenses = Profit
The new Profit First Formula:
Sales – Profit = Expenses
What you are about to learn isn’t anything new. It is something I suspect you
have been aware of—in full or at least in part—but have never done. It is the
concept of “pay yourself first” meets “small plate servings” meets “Grandma’s
hidden stash of money in the cookie jar” meets your pre-existing natural, human
tendencies.
Here’s how Profit First is like a successful diet:
1. Use Small Plates – When money comes into your main operating
account, immediately disperse it into different accounts in
predetermined percentages. Each of these accounts has a different
objective: one is for profit, one for owner pay, another for taxes and
another for operating expenses. These are the four basic accounts and
where you should get started, but you will get more advanced in
account setup as we move along.
2. Serve Sequentially – Always, always move money to your Profit
Account first, then to your Owner Pay Account and then to your Tax
Account, with what remains to expenses. Always in that order. No
exceptions. Move it, stash it and let it accumulate. And if there isn’t
enough money left for expenses? This does not mean you need to pull
from the other accounts. What it does mean is, you can’t afford those
expenses and need to get rid of them. This will bring more health to
your business than you can ever imagine.
3. Remove Temptation – Move your Profit Account and other
accounts out of arm’s reach. Make it really hard and painful to get to
that money, thereby removing the temptation to “borrow” (i.e., steal)
from yourself. Use an accountability mechanism to prevent access,
except for the right reason.
4. Enforce A Rhythm – Do your payables twice a month
(specifically, on the 10th and 25th). Don’t pay only when money is
piled up in the account. Get into a rhythm of paying bills twice a
month so you can see how cash accumulates and where the money
really goes. This is controlled, recurring and frequent cash flow
management, not by-the-seat-of-your-pants cash management.
When I started applying this small plate philosophy to my company’s finances, I
was doing consulting work and speaking on entrepreneurship. I also applied my
new Profit First system to my one surviving investment, Hedgehog
Leatherworks.
At the time, I was putting the finishing touches on my first business book, The
Toilet Paper Entrepreneur, into which I inserted a small section about the
concept of Profit First Accounting (PFA). After the book came out I continued to
refine the system, exploring and living it, and everything changed. I started
implementing it with other entrepreneurs. And it worked—for me, for them and
for my readers. I started getting calls from people who had read the book and
tried basic PFA, creating amazing results. I also decided to drop the “A” from
PFA—partly because Profit First is not an accounting system (it simply plugs
into your accounting system) and partly because, when I heard Facebook used to
be called “The Facebook” and dropped the “The” to sound cooler, I thought I
would follow suit and drop a word.
Fueled by my passion for entrepreneurship and my determination to be
profitable now, not at some indeterminate date in the future, I set about to perfect
my system. In that process I discovered other entrepreneurs and business leaders
who were running their businesses check-to-check and desperately needed the
Profit First system. But I also found entrepreneurs and business leaders who had
been implementing a similar system to great success. People like my barber, Lou
Leone, the second-generation owner of a barbershop that has been profitable
from day one. And Phil Tirone, who, while building his first, highly profitable
multimillion-dollar business, continued to rent the same studio apartment until
he determined that he had secured enough profit to upgrade—to a one bedroom.
In the coming pages, I will share these stories and more: stories about people
who are in lockstep with their profits and stories about other folks, like you and
me, who were giving it their all but still ended up only breaking even on their
best days—people who now turn a profit every month and enjoy the fruits of
their labors. People like Jose and Jorge, two entrepreneurs who started using
Profit First from the first day they discovered it and have not only experienced
very respectable growth, but have continuously taken in a 7% to 20% percent
profit, month after month.
Your story isn’t finished yet. Not in the least. It’s time to create your happy,
kickass chapter.
ACTION STEPS
GET YOUR BUSINESS PROFIT-READY
Step 1: Set up the small plates with your bank. You will need four accounts:
Profit Account, Owner’s Pay Account, Tax Account and Operating Expenses
Account.
You probably already have one or two accounts with your bank (checking and
savings). Keep the checking account as your Operating Expenses Account and
set up Tax and Profit as savings accounts (these are simply holding bins), with
Owner’s Pay as another checking account.
Some banks limit the number of transfers in and out of savings accounts. This
shouldn’t be a problem, since we will be using a rhythm. However, if your Tax
or Profit Accounts are checking accounts, that is fine. The goal is not to get a
little extra interest; the goal is to hold money temporarily and remove
temptation. Some banks charge fees or have minimum balance requirements.
Don’t let that deter you. Speak to the bank manager and negotiate the fees and
requirements. If the manager is unwilling to negotiate, find a new bank.
Step 2: Set up two more external savings accounts with a bank other than the
bank you use for daily operations. One account will be your no-temptation Profit
Account. The second will be your no-temptation Tax Account. Set them up with
the ability to withdraw money directly from the respective savings accounts in
your original bank.
Step 3: Don’t enable any of the “convenience” options for your two external
accounts. You don’t need or want to view these accounts online. You don’t want
checkbooks for these accounts. You just want to deposit your income and forget
it… for now.
CHAPTER THREE: The Naked Truth
It’s inevitable. Whenever two or more entrepreneurs are gathered together, one
of them will ask the “How big is it?” question. It’s always some version of the
same—“How big is your business?” It might sound like, “How many employees
do you have?” Or, “How many territories do you cover?” Or, if you’re one of
those straight-to-the-point types (like a few of my classmates at the high school
reunion), you might even be so bold as to ask, “How much did you take in last
year?” However it’s phrased, I hear some version of the “How big is it?”
question wherever I go—it’s like a law of the entrepreneurial (and porn)
community!
Many years ago, I joined a global entrepreneurial organization to learn from
successful, more experienced business leaders from all over the country. At one
of our meetings, I met my buddy Phil Tirone, founder of 720CreditScore.com.
Phil made his first fortune in the mortgage lending industry in California, so he
knows a thing or two about real wealth. Not the top line, or the outward
appearance. The bottom line. The actual take home money. The naked truth.
“When you get a loan, you take down your pants. You can’t hide anything,” Phil
told me as we enjoyed iced coffee outside his Phoenix home, staring at
Camelback Mountain in the distance.
“There are things that people don’t want to talk about. You don’t want to talk
about your lack of profit. You don’t want to talk about putting a second
mortgage on your home to help run your business. You surely don’t want to
admit to being the guy that has five times more credit card debt than the average
family in our debtors’ nation. After fourteen years of seeing entrepreneurs live
lives that are a bunch of lies, I look at the concept of wealth with such a skeptical
eye.”
Phil went on to explain that, more than just hiding the truth of their financial
situations, people aren’t just kidding the world around them; they’re kidding
themselves. “I did a loan one time for a guy who had a car payment of fortythree hundred per month. He said to me, ‘One day, when you’re successful,
you’ll have a car payment like this.’ I just smiled. This is what I’m supposed to
aspire to? Everyone’s perception of wealth is a joke.”
It was with this skepticism that Phil walked into the first global entrepreneur
meeting, and the second, and the third, hoping to connect with entrepreneurs
who, like him, cared about the bottom line. As usual, all he heard was the same
question over and over again. “How big is it?”
“All of the conversations were about revenue. Even the first conversation you
and I had, Mike. It’s bullshit. It’s total bullshit,” Phil said.
“Who cares about revenue? So you’re running a twenty or fifty million-dollar
company. You’re living in a crap apartment, dude! You’ve got nothing in your
accounts! The bank owns that car in the driveway. The credit card company
owns your furniture. Your elderly parents paid for your vacation. Are you
kidding me? What about profit? It makes no logical sense.”
It’s true. At our entrepreneur meetings there was little talk of profit, and many
people in the room were counting on the sale of their businesses to finally cash
in on their perceived success. When someone couldn’t cover payroll that month,
they would say they just needed one big project, or one new client, or an investor
to swoop in. It’s a common refrain among check-to- check entrepreneurs. One
more big sale. One new client. Someone to just throw a lot of money at them.
These entrepreneurs were giving it everything they had to just survive, with one
eye on the emergency exit sign.
I may not have been actively looking for an exit strategy while I ran my first two
businesses, but it was the sale of those businesses that gave me actual wealth—
and “permission” to act like an idiot. Would I have had the money to buy an
expensive “stable” (yes, I used the obnoxious term) of cars and invest in poorly
planned start-ups if I hadn’t sold my business? Nope. It doesn’t matter how
much money you have coming in, if you’re only focused on growth, you aren’t
going to have much to show for your “big” business.
The exit strategy you’re banking on? It rarely happens. My experience was the
exception, partly due to my being in the right place at the right time. Buyers,
investors, vendors and clients, too, are attracted to healthy businesses. Strong
businesses. But that seems to be a rarity nowadays. Doesn’t it?
Top line thinking (focusing on income) goes way beyond business. It’s definitely
part of American culture, this emphasis on size. Bigger is better. More, more,
more. Grow! Grow! Grow! Heck, I even wrote a book about how to do it.
As I said in the introduction to The Pumpkin Plan, I stand by my method for
growing niche-dominating businesses that lead to giant success. But we can’t
sustain that growth—or enjoy the fruits of our labors—if we keep putting profit
at the bottom of our to-do list. Are you really going to keep struggling as you
wait for that one big sale, that one big contract, that one big payoff that will
erase all of your debt, get you back in the black and allow you to finally cut
yourself a big fat check? It rarely happens and, when it does, the money seems to
evaporate fast. It’s a bit like asking Santa Claus for a million dollars, knowing
full well that he’s just a drunk guy in a red suit working at the mall (and for
God’s sake get off his lap).
I say we start a movement, right here and right now, to replace that tired old
misguided question about size and replace it with this one: “How healthy is your
business?” I’m serious—I can envision that question on t-shirts, hats, maybe
someone (hint: you, not me) even tattooing a questionable area of his body with
the slogan. Better yet, how about a blimp flying over Wall Street? That’s how
big a deal this is.
If you spend one more second worrying about the size of your business while
compromising a strong bottom line, your business is unhealthy at best. More
likely your business is dying a slow death. Big business is great, but only if there
are healthy profits. Small is great too, but only if there are healthy profits.
Medium is great, but only if there are profits there, too. You get the picture,
Goldilocks.
So, from this very second forward, ask only one question of yourself. Ask only
one question of your entrepreneurial friends. Ask only one question of any
business owner.
How healthy is your business?
Are you eating first, or are you surviving on leftovers, or worse— scraps from
the garbage can in the alley?
By the end of this chapter, you’ll answer that question; and whether your
business is dying or just a little queasy, we are going to get it back to full health.
I don’t care how much your business is struggling financially, the fact that you
are still in business means we can turn it around. Now, when people ask you
how business is going, you will respond with, “Healthy. Things are very, very
healthy!” And you won’t be lying to them or yourself. You can even get naked
to prove it.
THE (ALMOST) INSTANT ASSESSMENT
Whether your business is simply not as profitable as you would like it to be or is
in full cardiac arrest, I need you to be willing to keep your eyes wide open. In
order for Profit First to work, you need to come to this with no blinders on.
As you complete the Instant Assessment, remember that different businesses
have different setups. I’ll help you get to the perfect numbers for your specific
business in the next chapter. For now, know that, while the numbers I provide in
this chapter are ballpark numbers, they are a surprisingly effective way to get
started, and you may be surprised at how accurate this Instant Assessment really
is.
Figure 3 is the Profit First Instant Assessment form. Complete the form right
now! You can write right in this book (or, if you are on an iPad or Kindle or
some other reader and don’t want to replace the screen, you can download a
printable copy from the Resources section at Mike Michalowicz.com.)
1. In the Actual column, enter your Top Line Revenue for the last twelve full
months. This is your total revenue, and you should be able to pull this number
directly from your accounting system.
2. If you are a manufacturer or retailer, or if most of your sales are derived from
the resale or assembly of inventory, put the cost of materials (not labor) for the
last twelve full months in the Material & Subs cell.
3. If subcontractors deliver most of your services, put the cost of the
subcontractors for these twelve months in the Material & Subs cell.
(Subcontractors are people who work for you, but have the ability to work
autonomously and to work for others. You don’t pay them on payroll, you pay
them their project fee, commission or hourly rate, and they handle their taxes,
benefits, etc. themselves.) In some cases you will have both materials and
subcontractor costs (think home construction). In that case, put the cumulative
amount of these two costs in the Material & Subs cell. Remember to only put
your materials and subcontracts here, but not labor costs for your own people.
4. If you are a service company and most of your services are provided by your
employees (you included), put an n/a symbol in the Material & Subs section.
5. Now subtract your Material & Subs number from your Top Line Revenue to
calculate your Real Revenue. If you put an n/a in the Material & Subs section,
just copy the Top Line Revenue number to the Real Revenue cell.
6. The goal is to get you to your Real Revenue number. This is the real money
your company makes. For the other stuff—subs, materials, etc.—you may make
a margin, but it isn’t the core driver of profitability because you have little
control over it. This can be a real wake-up moment for entrepreneurs. That real
estate agency that does $5,000,000 in annual revenue and has a couple dozen
agents (subcontractors) taking $4,000,000 in commissions is really a $1,000,000
business that manages real estate agents making $4,000,000, not a $5,000,000
business. The $3,000,000 a year staffing firm that bills out subcontractors to do
work, and pays those subs $2,500,000, is really a $500,000 business. The
accounting firm that bills out $2,000,000 in annual fees and has an in-house staff
that does almost all the work has Real Revenue of $2,000,000 a year. The Real
Revenue number is a simple, fast way to put all companies on equal footing
(their Real Revenue numbers).
Real Revenue is different from Gross Profit, in that Real Revenue is your Total
Revenue minus materials and subcontractors used to create and deliver the
service or product. Gross Profit is Total Revenue minus materials,
subcontractors and any of your employee’s time used to create and deliver the
service or product. It is a subtle difference but a critically important one. Gross
Profit includes a portion of your employees’ time. But the thing is this: You will
generally pay your employees for their time whether you have a bad sales day or
a good one. You will likely pay them the same salary if they fix a car
transmission in four hours or five. So, to simplify things, we categorize any
employee that you have, full or part time, as a cost of the business operations,
not as a cost of the good sold.
7. Now that we know your Real Revenue, write down your actual profit from the
last twelve months in the Profit cell. This is the cumulative profit you have
sitting in the bank, or have distributed to yourself (and/or partners) as a bonus on
top of—but not to supplement—your salary. If you think you have a profit but it
is not in the bank and was never distributed to you as a bonus, this means you
don’t really have a profit. (If it turns out that you have less profit than you
thought you would, it’s likely you used it to pay down debt from previous years.
Or maybe you are attempting an Enron re-make.)
8. In the Owner’s Pay cell, put down how much you paid yourself (and any other
owners of the business) these past twelve months in regular payroll distributions,
not profit distributions.
9. In the Tax cell, put down how much money you have paid in taxes over the
last twelve months, plus any money you have already reserved for taxes.
10. In the Operating Expenses cell, add up the total expenses you paid for the
last twelve months—everything except your profits, owner’s pay, taxes and any
materials and subs that you have already accounted for.
11. Double-check your work by adding up your profit, owner’s pay, taxes and
operating expenses to see if you get your Real Revenue number. If you don’t get
this number, something is wrong with your calculations. Go fix it. Then, add
your Real Revenue to the Material & Subs costs and you should get the Top
Line Revenue number. Make sure it all squares out.
12. Next, enter the profit percentage in the PF % column based upon your Real
Revenue Range. Use the percentages in Figure 4. I call these percentages TAPs
(Target Allocation Percentages), the percentage of each deposit that will be
allocated to different elements of our business.
For example, if your Real Revenue for the last twelve months is $722,000, you
should use column C. If your business has $225,000 in Real Revenue, use
Column A. If you run a division (or have your own company) that does
$40,000,000, use column F.
13. In the PF $ column, copy the Real Revenue number from your actual
column. Then multiply that Real Revenue number by the PF % for each row and
write down the number in the corresponding PF $ cell. These are your target PF
dollar amounts for each category. Welcome to the moment of truth. (I hope we
can still be friends.)
14. In the Bleed column, take your Actual number and subtract the PF $ number.
This is very likely to result in a negative number. It is your bleed, the amount
you need to make up. Negative means you are bleeding out money in these
sections. Sometimes it is in just one category with a problem, but in most cases
businesses are bleeding out in the Profit, Owner’s Pay and Tax Accounts and
have a positive number (meaning excess) in Operating Expenses. In other words,
we are paying too little in profit, owner salaries, and taxes, and paying too much
in operating expenses.
15. In the final column, The Fix, put either “increase” or “decrease” next to each
category. If the number in the Bleed section is a negative number, put “increase”
in the corresponding Fix cell, because we need to increase our contribution to
this category to correct the Bleed. Conversely, if it is a positive number in the
Bleed section, put “decrease” in the Fix cell, since this is a category where we
need to spend less money in order to fix it.
Figure 5 is a completed example from a law firm to which I just introduced this
process: The Instant Assessment reveals a few (painful) things. This business is
not nearly profitable enough—it should be filling the profit coffers by $118,000
more every year. At $5,000 in the Profit Account, this is basically a break-even
business. One bad month and this company is going down.
The two owners are taking a combined salary of $190,000, which is way too
much for a business of this size. The owners are likely living a bigger lifestyle
than the business can afford, and they need to cut their salaries by $67,000.
As the business gets healthier, the taxes will increase. (More taxes, as painful as
they are to pay, are a sign of a healthy business—the more you make, the more
you pay… until you make so much you lobby politicians and pay nothing. Don’t
get me started.) And those Operating Expenses are too high, to the tune of more
than $141,000.
Looking at this Instant Assessment, it’s obvious what this company’s leaders
need to do to make their business healthy: Cut owners’ salaries and cut operating
costs, possibly including staff. It will require courage, and it is going to be
painful.
The Instant Assessment brings clarity fast, and it can be a rude awakening. No
more putting things off. No more hoping that big client, big check or big
anything will save you from the day-to-day panic. We know exactly what we
need to do.
A financially healthy company is a result of a series of small daily financial
wins, not one big moment. Profitability isn’t an event; it’s a habit.
WHY PERCENTAGES?
What if I told you I knew of a successful bikini model and fitness trainer who
weighs 205 pounds? You would assume she was seriously overweight, right?
How could she be a bikini model? Easy. She’s six foot eight! Amazon Eve is the
tallest bikini model in the world and, I’m telling you, she’s ripped. (Google her.)
Her weight is ideal for her height. Fitness is relative. Health is relative. So are
numbers.
In this book I use the phrase “top line” thinking, which is when you focus on
revenue, revenue first and foremost, with profit as an afterthought. Top line
thinking is dangerous because numbers are relative. You may have a million in
revenue, but that’s a whole lot of nothing if your expenses and debt load is also
seven figures. At $500K you might view your top line as meager compared to
other businesses in your industry, but if you’re pulling in eighty percent in pay
and profit, that is far from meager. That’s gorgeous. Super model gorgeous. And
if your business is showing fifty million in revenue, but pulling in two percent in
pay and profit, that’s ugly, my friend. Frankenstein, ugly. (And we all know how
ugly that is.) So, rather than focus on actual numbers alone, look at percentages.
Percentages show the relationship, giving you an accurate picture of what’s
really happening with your business.
HOW DID I DETERMINE THESE NUMBERS AND PERCENTAGES?
These are typical ranges that I have found while working with countless
companies over the years and in running my own. The percentages aren’t
perfect, but they are an excellent starting point. And they represent what I have
found to be very healthy numbers. But here is the deal—they may not work for
you perfectly, but that is okay because these percentages are your target, what
you will move toward. We are going to move in small steps. More on that soon,
but here are the deets behind the percentages.
When a company is doing less than $250,000 in revenue it typically has one
employee: you. You are the key employee and usually the only employee (with
some contractors, part-timers, or maybe possibly one full-timer). Many
freelancers are at this stage and if they elect to stay there (just them and no
employees) they should be able to increase the profit and pay percentages even
more than what I have listed, because they don’t have the expense of employees
or the need to incur the expenses necessary to support multiple employees.
At $250K to $500K, you likely have employees. Basic systems will be necessary
(like a shared CRM for your team), equipment, etc., plus you will need to pay
your people, so operating expenses increase. Owner’s Pay adjusts down (and
will continue to) as you take your first step in being a little less employee and a
little more shareholder, when other people start to do the work, and you get the
benefit of the profits via your distributions.
At $500K to $1M, the growth trend and patterns continue with more systems and
more people. Focus on increasing profits because, for so many businesses, the
growth from $1M to $5M is the hardest. You want a little reserve.
From $1M to $5M, systems are no longer added because they are nice to have;
now systems become absolutely mandatory. You can’t keep it all in your head
any more. Often the biggest investment into the business needs to happen at this
time, as all the knowledge in your head needs to be converted to systems and
processes and check lists. This means larger allocations must be put toward
Operating Expenses. This is when you are no longer doing most of the work; this
is when, if your business is to grow, a significant portion of your time is spent
working on the business (not in it), and the rest of your time is spent selling the
big projects.
At $5M to $10M, typically a management team enters a company to bring it to
the next stage, and a clear second tier of management starts to form. The founder
starts more and more to focus on her special strengths. The owner is on a
consistent payroll, and the majority of her take home income is from the
profitability of the company, not the salary she takes.
At $10M to $50M, a business will often stabilize and achieve predictable
growth. The founder’s income is almost entirely made up of profit distributions.
Owners’ salaries are relative to their roles, but typically are insignificant.
Businesses of this size can leverage efficiency in big ways to maximize
profitability.
RUDE AWAKENING
You might remember that during my “rebuilding” period, I wrote my first book,
The Toilet Paper Entrepreneur; the foundation of which was a series of
principles I used to start my businesses. Chief among these principles was
frugality—I wholeheartedly believed that any entrepreneur could start a business
with little or no seed money and grow that business no matter what they had in
the bank. The book is full of tips for saving money while launching and running
a business, and since its publication I’ve heard from thousands of entrepreneurs
who followed the advice (or a variant thereof) while starting or operating their
own businesses.
And let me tell you, I didn’t just spout off about frugality. After my spending
craze, after my come-to-Jesus moment (if Jesus were named “near bankruptcy”),
I went back to my roots. Way back. Not because I had to, this time, but because I
wanted to. I made it my mission to get what I needed for my business on the
cheap and took pride in doing so. My office space cost a mere $1000 per month
—peanuts compared to my previous $14,000 a month digs. I got my gently-used
conference room furniture for a whopping 75% discount. My dry erase board
was homemade, with white board material used in showers, dental floss and
some car wax. (Top that, MacGyver!)
So imagine my surprise when I ran my own assessment on my business and
discovered that, despite my frugal superpowers, I was still bleeding out. It is not
an exaggeration to say I was shocked to discover this. “How much cheaper can I
get this stuff?” I thought, beyond frustrated.
Then I realized—duh. It wasn’t how much I was spending on expense line items.
The problem was, I shouldn’t have been spending anything on some of those line
items. For example, I didn’t really need an office space. I wasn’t seeing clients
or greeting customers. I was writing a book and building a speaking career,
which meant I spent a lot of time alone, on the road and in phone and Skype
meetings. My subcontractors could just as easily do their work from home.
Truth was, I wanted an office space because it made me feel legitimate. And let
me tell you, after my piggy bank moment, I needed to feel that. But the bottom
line was, I couldn’t keep it up if I wanted to turn a profit every month. So I
sublet my office space and found a sweet deal at a cookie factory—free office
and meeting space from a trusted, long-time friend. I cut expense line items
across the board until I stopped the bleeding and watched my business and profit
grow. An added bonus was free cookies. And when I say added bonus, I mean it
added about five pounds around my waist. So… not really a bonus, after all.
For some people, the Instant Assessment brings about a rude awakening that is
far more devastating than mine. I’d already been through the wringer, so
realizing I had to cut a few line items was a shock, but not a big deal. Cutting
cost has become almost enjoyable. It has become strategic in a way. How can I
achieve the same or better with less or no cost? For Debbie Horovitch, whose
story I shared with you in the introduction, the rude awakening led to a near-
breakdown with a total stranger (me—so, you know, a “very handsome young
man,” according to my mom). It led to Debbie feeling like a fool.
I have applied the Instant Assessment to countless businesses, and the reactions
vary from, “Really? I can do that?” to “Who the hell do you think you are, Mike,
telling me where my business should be? You know nothing about my unique
industry!” to buckling knees and tears streaming down people’s faces. It’s hard
to face the harsh reality that your business is worse off than you thought it was.
But now you know, and knowledge is power. Now we can fix it.
You are not a fool. You have done nothing wrong, and you have nothing to be
ashamed of. You have this book in your hands. You are discovering the truth and
another way to get where you want to go. You are no longer asking, “How can I
make my business bigger?” You are asking, “How can I make my business
healthier?”
WHAT IF YOUR BUSINESS IS BRAND NEW
How does Profit First work if you just launched your business and have no
revenue? Should you wait until you have some to start using Profit First? Heck,
no. Starting with squat, with your whole business future ahead of you is actually
the best time to start using Profit First. Why? Because it allows you to form a
powerful habit right from the get-go, when your business is forming and,
perhaps more importantly, prevents you from developing bad financial habits
that can be difficult to break.
A baby is a poor indication of what a person will look like as an adult; the same
is true for a brand new business. You may end up serving a different type of
client than you plan to serve right now. I suspect the founder of Ugg, who
initially made the popular line for surfers, never imagined teenage girls would
become his primary market. Also, in the early stages of building a business, you
need to spend as much time as possible on the selling and the doing; systems and
processes come later. For these reasons, it’s best not to worry about getting the
exact right percentages for your business.
Simply use the percentages in the Instant Assessment for your target allocations,
but start at 1% allocation for the Profit Account, 50% for Owner’s Pay and 15%
for the Tax Account. Use quarterly adjustments to step up to higher percentages
and nudge your business closer to the TAPs recommended in this book. And as
for the advanced Profit First strategies I share in the end of the book—don’t
worry about any of that until your business has been active for at least a year.
The goal for new businesses is to form the basic core good Profit First habit and
then spend every other waking second getting your baby off the ground.
ACTION STEP
COMPLETE THE INSTANT ASSESSMENT
Step 1 (the one and only step): This entire chapter is really one big action step,
so if you have not yet completed an Instant Assessment on your business, do it
now. Can you get a lot out of this book if you table this exercise for when you
have more time or feel up to facing reality? Sure. Will you get the most out of
reading this book and see results quickly if you don’t? Nope. So stop right now
and do it.
PLEASE READ THIS NOW
If you are feeling overwhelmed, bad about yourself and the choices you’ve
made, or angry about the numbers you came up with in your Instant Assessment,
there is something I want you to know:
You are normal.
If you are having trouble facing the rest of this book, that’s okay. Stop now and
come back to it when you feel ready to face it. But do this one thing: set up a
Profit Account at a separate bank and, every time you make a deposit, move one
percent into that account. I know it’s “peanuts” and you may think the amount is
too small to make an impact on your business, but that is the reason you’re going
to keep the profit allocation percentage low. You can run your business as you
always have, and you won’t feel a thing, but you will start the habit that will
change your business forever. Soon enough, the feeling of being overwhelmed,
the anger and frustration, will fade as your new profit habit builds. Then you can
crack this book again and dig in to the rest of the Profit First system.
CHAPTER FOUR: Choose Your Own Adventure
When I was a kid, I loved reading Choose Your Own Adventure books (and quite
frankly, I’ll still dig into an R.A.
Montgomery book if it crosses my path). You know, the interactive books with a
message at the end of each chapter that says something like: “If you want to take
the path through the woods, turn to page 51. If you want to take the boat, turn to
page 80.”
Here’s your chance to relive a part of your childhood—you get to choose which
Profit First adventure you want to have next. The only difference between this
and the classic Choose Your Own Adventure books is, no matter which page you
turn to, as long as you follow the Profit First system you will be victorious.
Simply choose a path that fits your needs right now. But whichever path you
choose, the ending is the same no matter what: perpetual profit.
Let’s get to it. Time to pick your direction in your adventures in profit. You put
your sword back in its sheath. You raise your torch high, illuminating the room.
A large pile of cash sits in front of you, ready for the taking. You choose what
happens next:
1. You are the type who wants to continue on with this adventure,
now. So you quickly scoop up the pile of cash, stuff it into your
backpack and draw your sword, ready for the next challenge. (If you
want to start implementing Profit First right this second using your
Instant Assessment percentages, turn to Chapter 5.)
2. You are the type who accounts for the details. Is that a black widow
spider crawling amongst the bills? And what’s that slimy, slithering
thing peering at you from the corner of the room? Is it a snake—or
worse, an IRS agent?
You carefully count and stack every single dollar, write out a receipt
and place the money securely in your backpack. The next adventure
will surely present itself, but for now you’ll cross every T and dot
every I. (If you want to master the nuances of the Instant Assessment
and come up with percentages that are perfectly suited to your
business, then continue reading this chapter.)
Note: There are a lot of numbers in this chapter. If you choose option 2
and make it through this chapter alive, tweet me a selfie.
There is no wrong choice. You may want to jump right in and come back later to
tweak your percentages. Or you may want to come up with a customized
assessment so that you don’t have to come back later. Either way, as long as
you’re actually working the Profit First system, you’re winning.
GETTING DOWN TO THE NITTY-GRITTY
The Instant Assessment is based on ranges. Every business is slightly different
(though your business and your industry are not nearly as unique as you may
think). The numbers you came up with in the Instant Assessment won’t be
perfect, but they are probably close to what you’ll end up with after a more
detailed assessment.
Before we dig in, I want to address two common problems entrepreneurs face
when they decide to start following the Profit First system—and they do not go
hand in hand.
First, some entrepreneurs make the mistake of getting trapped in the details,
spending hours, days, weeks or longer perfecting their percentages before they
do anything. Worse, some entrepreneurs who get stuck in the minutiae never get
around to doing anything. It’s our old nemesis: analysis paralysis. In this
chapter, we get down to the nitty-gritty; but if at any time you think you are lost
in a research and percentage-tweaking rabbit hole, stop and move on to the next
chapter. Perfectionism kills every dream—better to just start.
On the other hand, if you’re like me, you might make the common mistake of
taking action too big and too fast. I’m the type who starts before I have all of the
information because most of the learning occurs in the doing, anyway. But I put
success at risk when I go into a situation ill-prepared. In those cases, my ego
blames the system when mistakes were simply due to the fact that I didn’t put in
the necessary preparation.
I’ve seen entrepreneurs kickstart their Profit First system by taking a profit
percentage of twenty percent immediately. They say, “This is so simple. I get it.
Bammo! Twenty percent! I’m done. Next problem.” Not so fast, Chiefy. This is
a classic mistake, one I’ve made myself. Going full-throttle Profit First on the
first day is like donating five gallons of blood at your first blood drive. You
know what would happen if you tried to do that? You would die. The body has
less than two gallons of blood pumping through it, so you’d keel over way
before you reached your five-gallon goal anyway. However, there is a way to
reach that goal in a safe way. If we donate small amounts over time, eventually
we will donate five gallons—cumulatively.
If you hoard most of the food at the table, you’re not leaving any fuel for your
business. Remember, your business, not you, is now living off of the leftovers.
So make sure the share you take leaves enough for your business to continue to
thrive. Rather than go with one extreme—too slow or too fast—let’s just meet
somewhere in the middle.
The key to successful Profit First implementation lies in stringing together a
series of many small steps in a repeating pattern. So take it easy.
While you slowly start to build up your Profit First muscle, we are also going to
get you into a simple, repeating pattern. All music has a rhythm. Rhythm is what
moves the music forward, and moves you. Otherwise it would just be random
noise, and you would never be moved by it. Entrepreneurs typically manage
their money in an erratic, noisy rhythm that causes confusion and panic. But by
the end of the next chapter, we will get you into a simple rhythm that will give
you clarity and control over your financials.
Let’s dig in.
YOUR PROFIT TARGET ALLOCATION PERCENTAGES (TAPS)
The Instant Assessment is a starting point for all of your Target Allocation
Percentages (TAPs). TAPs are the goals we have set to distribute to each account
based on percentages. We may want to ultimately be tucking away 20% of our
accumulated deposits; if so, 20% would be the TAP for Profit. We won’t
necessarily start there, but we will build to it.
Now you need to do a little bit of research to set more specific target numbers.
There are a few ways to approach this:
1. Research public companies: Look at the financial reports public
companies are required to make available. Do a quick Internet search
using the term “financial market overview” and you will find dozens
of websites that report the financials for public companies. Look up at
least five companies in your industry, or a similar industry. If you
don’t find your niche, try expanding. For instance, if you find no
public DJ companies, expand to entertainment companies and select
five that come close. (Tip: My preference is Marketwatch. com for
these reports, because the site is easy to navigate. You might also try
Yahoo! Finance and Google Finance.)
For our purposes, look up the income statements for the last three to
five years. If you really want to dig in, check out the balance sheets
and cash flow statements for these companies, too.
For each year, divide the net income (profit) number by the total
sales/revenue number. Do this for each year and then come up with the
average. This is how you find the profit percentage for any public
company. Do this for each of the five public companies you look at,
and you will find the overall industry profit average.
Use that overall industry profit average as your Profit TAP.
2. Review your tax returns for the last three to five years and
determine your most profitable year (based on percentages, not on
dollar amounts). Why do we want the percentage? Because a billiondollar company that only reports a million dollars in profit is in big
trouble. Even if they only had one bad day, a million bucks wouldn’t
be enough to bail them out. But a five million-dollar company that
reports a million in profits is kicking butt and taking names. That lil’
ol’ company spits at bad days.
3. Or, the easiest way, just pick your profit percentage number based
on your projected revenue for this year, using revenue for the last
twelve months from the Instant Assessment form you filled out for
Chapter 3. (You did fill it out, right?) Remember, the form is also
available for free download in the Resources section at
MikeMichalowicz.com.
If more than half the stuff your company sells comes from materials rather than
labor or software—as happens with manufacturers, restaurants and retailers—
use the gross profit (sometime called gross income) as the Real Revenue
number. Gross profit is calculated somewhat similarly to how I suggest you
determine your Real Revenue, and you need to evaluate your business based on
that. Whenever you run the numbers for your business, or evaluate others, you
will always base it on Real Revenue (gross profit).
Since at this point your Profit Account will fund your profit distributions and
serve as your rainy day fund, you’ll want your Profit Percentage to grow past
five percent quickly. If you save five percent of your company’s annual income,
for example, that represents about twenty-one days of operating cash, which
would help you keep your business afloat if your income were to plummet. (If
your income dried up, you would stop contributing to your Profit Account and
Tax Account and stop profit distributions to owners.) Three weeks is not much
time to fix the problem, but Armageddon rarely happens. More often, revenue
slows down over time, and you’ll have at least something coming in during lean
times. Kinda like a “Hangnail-ageddon” instead of an Armageddon. (It’s a bad
joke, I know, but I like it. So it stays.)
If your sales were to stop completely, with not a single deposit coming in, here’s
a good longevity rule of thumb:
1. 5% profit allocation = 3 weeks of operating cash
2. 12% profit allocation= 2 months of operating cash
3. 24% profit allocation = 5 months of operating cash.
Why is it that, as the PF percentages basically double, longevity almost triples?
The math doesn’t seem to make sense at first glance. But it does make sense.
The bigger your PF percentage, the more efficiently you are running your
business, which means less in operating expenses. So not only do you have more
saved up with a higher PF percentage, you spend less, which affords you even
more time.
The goal is to make your PF as high as possible. However, super-high profit
percentages are not sustainable. At least not for long, and definitely not if your
revenue stays stagnant. The reason for this is, if you can pull off consistently fat
profits—say 50% allocated to your Profit Account—and your Operating
Expenses Account for only 10% of revenue, your competitors will figure out
what you’re doing. Then, to get more business, they will drop prices (they likely
have the profit margins to afford it). When that happens, you will have to drop
prices too in order to stay in business. For competitive sharks, fat margins can be
like blood in the water. The only way to keep big margins is to milk them for all
they’re worth when you have them and keep innovating to find new ways to
bump up profitability.
OWNER’S PAY TAPS
Gone are the days when you paid everyone but yourself and had to support your
life with credit cards and loans from the in-laws. Remember, your business is
supposed to serve you; you are not in service to your business! No more
leftovers for you!
Owner’s Pay is the amount you and the other equity owners take in pay for the
work you do. (Equity members of your company who do not work in the
business just get a profit distribution.) Your salary should be on par with the
going rate for the work you do, in other words—the salary you would have to
pay your replacement.
There are two options to consider when choosing your Owner’s Pay TAPs
number. Either:
1. Take a realistic look at the work you do. If you have a small
company with, say, five employees, you may call yourself the CEO—
but that’s just the title on your card. Likely, you are doing a lot of
other work. You probably spend a lot of time selling, completing
projects, handling customers and dealing with HR concerns. In reality,
around two percent of your time is spent actually doing the job of CEO
—vision planning, strategic negotiations, acquisitions, reporting to
investors, addressing the media, etc. Determine your salary based on
what you are doing 80% of the time, and what you would reasonably
pay employees to do those jobs.
2. Evaluate pay for all equity owners who work in the business. Add
up the salaries that represent your Owner’s Pay draw. The percentage
of revenue must, at minimum, cover Owner’s Pay draw. Remember,
you will likely get raises—maybe even a bonus for a job well done. So
make the percentage one-and-a-quarter times the amount you
determine for your salaries, so you can adjust for revenue fluctuations.
Or, pick the percentage I suggested in the Instant Assessment, based on your
revenue range. (Refer to Figure 4.) The money that is transferred into this
account is divided among all equity employees. It does not have to be split up
equally, nor does it have to be split up based on your equity percentages.
Why should you have a separate account if you and the other equity owners
working in the business are just employees? Because you are the most important
employee. If you had to fire people, I suspect you would fire everyone else
before you fired yourself. Think about your very best employee. I’ll bet you take
extra steps to ensure that you are taking care of her. I’ll bet you would do
everything in your power to keep your best employees happy, including paying
them what they’re worth, right? Well guess what, Bucko! You are your best,
most important employee. We must take care of you.
When it comes to pay, different business formations require you to take Owner’s
Pay in different ways. An S -Corp is treated differently than an LLC or a sole
proprietorship, which are both treated way differently than a C-Corp. The
Owner’s Pay allocation still works the same way; you just need to work with
your accountant to make sure the money flows out properly and legally. (I
strongly recommend an accountant who is a certified Profit First Professional,
meaning they get this and know exactly how to support your Profit First
business.)
WHEN YOUR CURRENT PAY IS LESS THAN THE ASSESSMENT
I was having dinner with my friend Rodrigo when he told me how his business
generated $350,000 in annual revenue, but he was living on below-minimum
wage.
As a thunderstorm approached in the distance, I took the napkin with the least
amount of salsa stains and jotted down Rodrigo’s numbers. Multiplying his
$350,000 in Real Revenue by 35% (from the Instant Assessment), I came up
with just over $122,000.
“How many partners work in the business?” I asked. “Me, and one other,” he
replied.
Dividing by two, the amount for owner’s pay was a little over $61,000 each, but
that was if they were doing the same work, warranting a fifty-fifty split. As we
discussed in the previous section, owner’s pay should represent the work you do.
When I asked Rodrigo for more details about his own pay, he said, “I take
roughly $30,000 a year, and my partner left to get a full-time job, so he takes
zero now. We have three full-time employees at $65,000 each per year, and I
manage them.”
I’d like to say I was shocked, but this scenario is all too common. I did wonder
how Rodrigo was supporting himself and his family on below-minimum wage. I
figured he was using credit cards, family loans and possibly a home refinance to
supplement his paltry income.
“If all three of your employees decided to leave on the same day, what would
you do?” I asked.
“I would do all of the work myself and my partner would come back.”
“So why don’t you do that?” I asked.
“Because then I would be stuck doing the work and it would not be able to
grow,” Rodrigo explained. “I don’t want to do the work; I want to grow the
business.”
Rodrigo had the right idea, but he was executing it in the wrong way.
In The E-Myth Revisited, the classic must-read book by Michael Gerber, Michael
explains that we should work on our business, not in it. (Yes, I call him Michael.
We are friends. He calls me Mike and I call him Michael. And occasionally I
call him Mike and he calls me Michael. And then we both get confused and start
talking to ourselves.)
This “on vs. in” philosophy is spot-on, and yet most entrepreneurs have trouble
executing it. Working on the business does not mean hiring a bunch of people to
do the work and then spending all the livelong day answering their never-ending
questions about how to do the job (the job you used to do). Shifting to a
managerial role just means you are working in your business in a different way
—and that you have a mongo payroll to cover every two weeks.
Working on your business is about building systems. Period. An entrepreneur is
someone who finds the solutions to opportunities and problems and then builds
systems to consistently deliver those solutions through other people or things.
However, what Rodrigo and so many entrepreneurs miss is that growing a
company is not an overnight switch from doing all of the work to none of the
work. The transition from working in the business to working on the business
happens over time—slowly, deliberately, one small step followed by another
small step. (Are you starting to see the theme here?) This is the reasoning behind
the Owner’s Pay percentages in the Instant Assessment—larger percentages for
owners when the company is tiny and smaller percentages as the company
grows.
In the early days of a company, when annual revenues are below $250,000, you
are not only the most important employee; you are likely the only employee. If
your annual revenue is under $500,000 and you have an employee or two, you
are still the key employee. And that means you must be doing 90% of the work.
You’re bringing home the bacon and frying it up in the pan.
The other 10% of the time you spend documenting everything you do so that you
can systematize it for your other few employees or contractors to do the work
without your input. Basically, you are a true entrepreneur (building systems)
10% of the time, and a hardworking, hard-selling employee of your own
company 90% of the time.
This is why you get such a big salary in the beginning. No more of this “bottom
of the bowl” stuff. You can’t live on minimum wage or less. Say it again, once
more with feeling: My business serves me; I do not serve my business. Paying
yourself next to nothing for hard work is servitude.
As your annual revenue grows past $500,000, you will transition to spending
more time building systems. Now, you’re a systems developer 20% of the time,
a manager 10% of the time and an employee 70% of the time. (Note that the
better you are at creating systems, the less management is required, because the
recipe for how to things get done is consistent.)
As annual revenue grows past one million, your salary percentage will drop even
farther because you will be working less and less in the business and more and
more on the business.
However, remember that it is likely you will always work in your business.
Because even if you are a master of building systems and spend 80% of your
time in that magic zone, you’ll still spend roughly 20% of your time handling the
big sales. Almost every entrepreneur to CEO is in charge of the big sale. You bet
your bottom dollar Jeff Bezos is in the room when Amazon is closing a hundred
million-dollar deal. And when your big deals are on the table, you will be right
there, sitting at its head.
Ironically, getting back in your business is the best way to create systems. And
as you put the systems in place and your revenue increases to accommodate
them, you can slowly plug in great people to implement those great systems.
The bottom line is this: Don’t cut your salary to make the numbers work. The
goal of every business is health, and that is achieved through efficiency. Your
martyr syndrome is not doing anyone any favors; making yourself the sacrificial
lamb does not promote efficiency, it hinders it.
YOUR TAX TAPS
Profit First is not about accounting to the exact penny (that’s what your
bookkeeper and accountant do). It is about handling your accounting quickly and
easily, with numbers that are as close to accurate as possible. We work
percentages off of the Real Revenue number and this is true for all your “small
plate” accounts.
The first step in getting to your Tax TAP is to determine your income tax rate.
Taxes range all over the place, depending on your amount of personal income
and corporate profit and the area you live in. As of this writing, many
entrepreneurs have an average income tax rate of 35% or so; for others it will be
less, and in some countries is can be 60% or more.
When I traveled to Copenhagen, Denmark, the beauty of the country blew me
away: the resources they have, and all the “free stuff”—the free healthcare, the
free education (including universities), and the free-flowing confidence that they
live in the best place in the world, which is kind of funny, because I always
thought North Korea held that title.
Then my friend Lori Webb told me that the Danish tax rate is over 60%. I
practically fell off my chair.
Taxes vary from country to country, income bracket to income bracket, and
surely change everywhere every year (and, I think, in world history, never once
in our favor). But regardless of what the numbers are, you need to prepare for
them.
One goal of the Profit First system is that the company takes care of all forms of
tax responsibility. It’s mandatory that you talk with your accountant so she can
advise you on all the ways you and your business will be taxed.
Here are four different approaches for determining your Tax TAP:
1. Look at your personal and business tax returns. Add up your taxes
and then determine the percentage of taxes you paid compared to your
Real Revenue. Do this again for the prior two years. Looking at your
taxes as a percentage of Real Revenue for the last three years will give
you a good sense of your ongoing tax responsibility.
2. From your accountant get your estimated tax responsibility for your
business, year-to-date (YTD), and then determine your tax percentage
of your YTD Real Revenue. Better yet, if your accountant is a certified
Profit First Professional, she can simply tell you the percentage to
reserve. (For a list of accountants, bookkeepers and other financial
gurus who are Profit First Professionals, go to the Resources section at
MikeMichalowicz.com.)
3. Do a search for “tax rates” + “your country” + “tax year.” For
example, “tax rates United States 2013” yielded the following results
on Google:
Tax Rate Schedule Y-1, Internal Revenue Code section 1(a)
10% on taxable income from $0 to $17,850, plus
15% on taxable income over $17,850 to $72,500, plus
25% on taxable income over $72,500 to $146,400, plus
28% on taxable income over $146,400 to $223,050, plus
33% on taxable income over $223,050 to $398,350, plus
35% on taxable income over $398,350 to $450,000, plus
39.6% on taxable income over $450,000.
Then, pick your likely income range—which depends on the type of company
formation you may have and the combination of your Owner’s Pay and Profit
contributions— and you have your federal tax rate. Now do the same thing for
state taxes and add the two.
4. Or simply use 35% as your tax number. It may not be perfect, but
it’s usually pretty effective. And while the optimal number will have
you neither paying additional taxes at the end of the year nor receiving
a refund, it is better to guess a little too high, get a refund and consider
what to do with the extra cash than to get a call from your accountant,
Keith, because you don’t have enough money, and have to ask your
daughter if you can borrow from her piggy bank. Trust me.
But hold on: If the tax rate is 35%, why would I only reserve 15% for taxes (as
noted in the Instant Assessment I shared earlier)? Let’s do a little simple math.
A LITTLE SIMPLE MATH
Now we are going to determine the percentage that stays in your Operating
Expenses Account, after you move money to your Profit Account, your Owner’s
Pay Account and your Tax Account. The amount left over for expenses is likely
going to be somewhere between 40% and 60%. This is the money you have
available to pay all your expenses.
Next, subtract that percentage from 100%. So, if your total Operating Expenses
Account is at 55%, you’re left with 45%. That 45% is the amount you will be
taxed on. (More often than not, expenses are not taxed. This is why some
accountants encourage you to buy equipment or make other large purchases
toward the end of the year.) Now, multiply your non-operating percentage (in
this case, 45%) with your taxable income percentage (in this case, 35%). You
end up with a percentage of approximately 16%, which is your Tax percentage.
Now that you have a more accurate picture of your actual percentages, you’re
ready to get started. In the next chapter we’ll take you through the first year of
Profit First, and beyond, and outline everything you need to know from day one.
Congratulations! You survived. Send me a selfie.
I can sense your hunger to put this into practice in your business. Wipe that drool
off your chin and let’s start doing it. Things are about to change around here.
ACTION STEP
APPLY YOUR ADVANCED KNOWLEDGE
Step 1: Following the steps detailed above, determine your custom Profit,
Owner’s Pay and Tax percentages based on your industry and other factors.
Step 2: Since you chose to get down to the nitty-gritty and determine your exact
Profit, Owner’s Pay and Tax percentages, stop now and adjust the numbers in
your Instant Assessment form.
CHAPTER FIVE: Day One, Quarter One, Year One
and Forever
Profit First works. Period. Whether you use the percentages I provided for you in
the Instant Assessment or choose the path of assessing all the nuances of your
business and industry (see Chapter 4) and arrive at your own perfect allocation
percentages, it will work. How can it work with different percentages, you ask?
Because your Target Allocation Percentages (TAPs) for your Profit, Owner’s
Pay and Tax Accounts are simply targets—you aren’t going to start with them,
you are going to build toward them. And as you build, you will transform your
business into a lean, mean efficiency machine that generates profit on every
deposit, no matter how small.
Remember, the Profit First formula flip is easy:
Sales – Profit = Expenses
If you’re still stuck on finding your percentage, let me tell you a little story about
the power of just doing it. This is a story I heard secondhand, maybe even
seventeenthhand; I’m not sure. And while I don’t know exactly whom the story
is about, don’t doubt the story. It goes like this:
An up-and-coming motivational speaker went to a speaking boot camp. During
one of the sessions, the instructor explained how to make back-of-the-room
sales. He said, “When you follow this method, eighty percent of the audience
will buy your product at the end of an event.”
With pages of notes and tons of enthusiasm, our up-and- comer set forth on the
speaking circuit. Initially, she closed only 25% of her audiences. Reaching for
that 80%, she tweaked and improved her strategy and pitch, constantly
reviewing her notes. Over time her close rate rose to 50%, then 60%. After
another year, she was consistently selling 75% of the room after her speech. She
had achieved outstanding results, but not to the level her instructor had
promised.
One morning, she sat down to breakfast with a few colleagues and her old
instructor happened to be there. She couldn’t wait to speak with him and get
direction about what could help her get that last, elusive 5%. What was the secret
to finally breaking 80%? When she told her story to her instructor, his jaw
dropped.
“Eighty percent? You thought I said eighty percent? I said eighteen.” I tell you
this story to illustrate something I believe to be true because I’ve experienced it
—no matter what the number is, if you work toward it and believe it’s a
possibility, you will not only achieve it, you will blow past the “reasonable”
numbers others have set.
If you made the detailed assessment in Chapter 4, you probably looked at quite a
few public companies that are in the same space you are. You have seen their
numbers. You have seen their “reasonable” 18%. That’s my fear.
Even if you are following my guidelines and pushing for healthy profits of 15%
or 20%, the number may be too low. Many companies have absolutely done
better. Million-dollar companies have posted 40% or more in profits. Yes, they
are the exception, but someone has to be. Why not you? Why not choose to hear
80% when the rest of the world chooses to hear 18%?
In this chapter, I will teach you exactly how to implement Profit First, step by
step, day by day, month by month, and so on. Your Profit Percentage may seem
steep or out of reach, but by the end of this year you will be closer to it than you
thought you could be. You may even leave it in the dust.
BEFORE WE BEGIN, MEET THE PRIDE OF PROFIT FIRST
When Jorge Morales and Jose Pain started Specialized ECU Repair in 2007, they
dreamed of one day enjoying what they perceived to be the big perk of owning a
business: profit, or, extra money to spend on their own interests. (Jorge is really
into free diving and Jose has a serious thing for model airplanes.)
Here’s where many seasoned entrepreneurs chuckle knowingly under their
breath because they think this Jorge and Jose are dreamers. Don’t they know that
entrepreneurship is about personal sacrifice? Unless they’re exceptionally lucky,
it will be a long time before they earn enough extra cash to indulge in their little
hobbies… right?
Wrong.
Two years into operating their own business, Jorge and Jose had decided the
only way they could reap the benefits of entrepreneurship would be to increase
their salaries a little bit each year. (They were better off than most entrepreneurs
in that they did have enough to pay their own salaries and hadn’t fallen into the
death trap of debt.)
Then they read the small section on Profit First Accounting in my book, The
Toilet Paper Entrepreneur, and began applying the system almost immediately.
Over the next few years, Jorge and Jose tweaked Profit First to suit their rapidly
growing business, adjusting their Profit Account percentages and allowing Profit
First to control that growth so that they never ended up underwater because of
large purchases or a ridiculously high payroll.
Four years later Jorge and Jose have a thriving business that, in 2013, surpassed
their accountant’s revenue projections. Their staff has tripled, but thanks to their
shrewd, careful planning and the Profit First system, they are not struggling
under the weight of too-high operating expenses.
More importantly, their business is serving them, with salaries appropriate for
their positions and the work they do at Specialized ECU Repair, and with
significant Profit Account disbursements that have enabled them to live the
lifestyle they envisioned when they started the business.
The dream all entrepreneurs have—that our business will improve the quality of
our lives, not destroy it—Jorge and Jose are living that dream. They do not serve
their business; their business serves them.
DAY ONE
TELL YOUR PEOPLE
Before you begin, I want you to tell your accountant what you’re up to. A
warning—he might not “get it.” He may say the system is useless, or it won’t
work, or it’s technically wrong or it’s too much hassle. If your accountant
discourages you from using Profit First in your business, it is because he does
not fully understand cash flow management or human behavior. Get a new
accountant.
Jorge and Jose included their financial professionals in the implementation of
Profit First right from the start.
“When we first learned about Profit First, it made sense to us,” Jorge told me, in
one of our many phone calls about their progress. “I pulled the numbers and
then, with our bookkeeper and accountant, we did a projection for the year. Then
we worked in the Profit Account percentage we wanted to start with.”
With buy-in from their accountant on the principles and processes of Profit First,
Jorge and Jose have been able to systematically apply the method to their
business with great success. Their accountant helps them meet their Profit First
goals and stay the course.
To make your life easier, I have compiled a list of accountants, bookkeepers,
financial planners and others certified as Profit First Professionals. They not only
get Profit First, they use it for themselves and they use it with their existing
clients. You can find the list on the Resources section at MikeMichalowicz.com.
There you will also find a Profit First One-Sheet that gives a basic overview of
the system so that all of your key financial staff/ vendors can get up to speed
within a few minutes.
SET UP YOUR ACCOUNTS
If you didn’t set up your accounts after reading Chapter 2 (shame on you), do so
now. Most bank accounts allow you to assign a nickname to the account that is
displayed, rather than just the account number. Give each account a name that is
easy to identify and then put the percentage (or dollar amount—I’ll explain that
in Chapter 9) in the name in brackets. This makes running Profit First so much
easier. For example:
OPERATING EXPENSES [45%] *8812
OWNER PAY [25%] *8833
PROFIT [15%] *8843
TAXES [15%] *8839
START OUT EASY
We are making progress now, baby! We have the accounts set up at your bank!
Yippee. We have determined your TAPs. Now we’re going to start with a
manageable Profit Percentage that will allow us time to cut down on expenses
and adjust to the new system.
We’ll start at our historical contribution levels for each account and then add
1%. This may mean you start from zilch. If your business has never had a profit,
or if you have sometimes had a profit and sometimes a loss, your profit has been
zero. Therefore, our easy start for the Profit Account will be 1% (that’s 0%
historically plus 1%, starting today), and we will bump it up as we start getting
into our quarterly rhythm.
If your taxes were usually 5% of your total revenue, we are going to set up your
tax reserve at 6%. If your pay represented 20% of your income, we add 1% to
your 20% and you have 21%. And so on. Even if our targets are much higher,
we start with what we’ve got, plus 1%.
Why start with small percentages, when we likely could do more? The reason is,
the primary goal here is to establish a new, automatic routine for you. I want the
amounts to be so small you don’t even “feel” them. The goal is to set up these
automatic allocations immediately, and then adjust the percentages each quarter
until we are aligned with our TAPs.
Practical to the core, Jorge and Jose started out with a modest Profit First
percentage of 2%. (Because their decision was made more than four years ago,
before I finessed this system, their number was not based on the “1% rule” I’ve
just shared with you.) They chose an allocation of 2% because initially, Jorge
was reluctant to begin implementing Profit First—even though he knew it made
perfect sense.
“I think by going slowly, I was able to see how Profit First could work,” Jorge
explained. “What it really came down to was, I realized that at two percent, there
was no excuse not try it. Because if your business can’t afford to set aside two
percent of your revenue, it’s probably not a business worth pursuing.”
Start slow. These percentages you set are your quarterly allocation percentages.
We are going to use them for the rest of this quarter, whether the quarter begins
next week or in ninety-one days.
PROFIT STARTING TODAY
You know the saying, “Today is the first day of the rest of your life.” I love it. I
absolutely love it. To me, it represents the profound realization that we can
change our lives (and our businesses) in a moment. Now is the time. This very
moment we will make a profit for your business, and we will be profitable every
day going forward. Please don’t just read this and move on to the next chapter. I
want you to take action now.
Right now, this moment, look at your bank balance in your Operating Expenses
Account. Then subtract any outstanding checks and payments you have from
that account. Divide up the remainder into your accounts based upon your TAPs.
For example, say you have $5,000 in your bank account, and you have $3,000 in
checks and payments still waiting to clear. That means you have $2,000
currently available. Run your percentages on that $2,000 and move that money
into the accounts.
Do you have any deposits to make today? If so, tally up the deposits, put them in
the bank, and then immediately distribute the money to all the other accounts. Do
this for every deposit going forward.
(Don’t worry: you don’t need to do this every single day, or many times a day, if
you have lots of deposits. We are going to get you into a twice-a-month rhythm
shortly that will make this process very manageable.)
OUR FIRST CELEBRATION
Congrats! And I am not saying that lightly. You’ve just taken a big step. This is
likely the first time in your entire business life that you have deliberately
accounted for your profit first. Before anything else, you made sure you
addressed your profit, your personal income and your tax responsibilities. That’s
a big deal. And it is a big step to a very, very healthy business. Kudos to you.
SLICE EXPENSES
Now that we are moving money into our Profit, Owner’s Pay and Tax Accounts,
we need to get the money from somewhere. There are only two ways to do that:
by increasing sales and by cutting expenses. Increasing sales is very doable (you
did read The Pumpkin Plan, right?) and is the key for colossal profitable growth.
But it takes time and it won’t happen overnight. Cutting expenses is generally a
very quick process and is usually very easy.
Jorge and Jose run their business based on what they can afford today, not what
they hope to be able to afford someday. So sometimes they have to wait to hire
someone or make a high-ticket purchase.
“When big expenses showed up,” Jorge explained, “we would sit down and ask
ourselves, ‘Do we really need this?’ If we determined it would hurt our profits at
the end of the year, we didn’t buy it.”
We just accounted for at least 3% (1% in each of the Profit, Owner and Tax
Accounts) of our income, so we need to cover that by cutting 3% from our
expenses. To do that, I need you to print out two things:
1. All your expenses for the last twelve months.
2. Any recurring expenses: rent, subscriptions, Internet access,
training, classes, magazines, etc.
Now add up all the expenses and then multiply that number by 10%. You must
cut costs by 10%. Now! No ifs, ands or buts! So why cut by at least 10%, when
we “only need 3%”? Because cutting costs doesn’t mean the bills go away
overnight. It may take a month or two to pay down balances owed on expenses
we eliminate. More importantly, we need to start building cash reserves, because
by the start of the next quarter, we are going to move another 3% to your Profit,
Tax and Owner’s Pay Accounts, and then another 3% the quarter after that. So
we want to account for that money quickly.
You can easily find your first 10% in cuts by doing the following:
1. Cancel whatever you don’t need to help your business run
efficiently and keep your customers happy.
2. Negotiate every remaining expense, except payroll.
I share a lot more about cutting expenses in the coming chapters. You are about
to become a frugal (not cheap) entrepreneur. You will learn to use only what you
need and not be wasteful. You will pay fairly for what you use, but you will use
less. And you are going to love it.
MONTH AFTER MONTH
THE 10/25 RHYTHM
You remember my friend Debra Courtright, the bookkeeper who helped bail her
client out of sales tax hell? When I first taught her how to use Profit First with
her clients, I drove to her office in Fairfield, New Jersey to spend the day going
over all of the advanced strategies. Just an hour into our training day, she had not
only mastered the concepts, she was on the phone with one of her clients,
helping her set up a Profit Account.
I always have my mobile office with me (backpack with laptop, other electronic
gadgetry and critical lifesaving essentials—like Milano cookies). So while Debra
went over the basics with her client, I knocked out a few tasks on my to-do list. I
knew I had some bills due, so I went into my online bank account, looked at the
Operating Expenses Account and ensured that all of the disbursements were
current. Yep—Profit Account was up to do date. Tax Account looked good.
Owner’s Pay Account—check. Other advanced accounts we’ll discuss later in
the book—all good. Now it was time to pay my bills from the Operating
Expenses Account.
“What are you doing?” Debra asked, startling me.
I had no idea she was behind me, and I practically spit out my coffee. If you met
Debra, you would never guess that she is a fully trained super-ninja or
something. But she must be, because she has an ability to just appear next to you
without you noticing. My tip? Avoid drinking any form of liquid when she’s
around; you will either gag on it or spit it all over the table when you look up
and see super-ninja Debra clinging to the ceiling above you.
“I’m paying my bills,” I replied. “Why are you paying them today?”
Confused, I replied, “Um. . . because I have time, and they’re due.” Debra said,
“Well, that’s not smart.” (Ninjas don’t mince words.) “What do you mean?” I
asked.
That’s when Debra taught me the 10th and 25th cash flow rhythm— paying
expenses twice a month, on the 10th and 25th. And that was the day the 10/25
Rhythm became integral to Profit First. Thanks, Debra! (If that is your real
name.)
I implemented the process in my business immediately. I let the bills come in,
and I deposited income, but that was it. I no longer did accounting when I had
time, or when someone called to check and see if I’d received an invoice. I got
into a rhythm. I did my accounting every 10th and 25th (or the business day
prior, if the 10th or 25th fell on a weekend or holiday). I chose those days so my
payments arrive by the 15th and the end of the month, when most bills are due.
For our benefit we want to get into a rhythm of twice a month, and for our
vendors benefit we want to make sure we pay them on time.
First, I tallied all the new deposits that had gone in over the last few weeks and
did the Profit First allocations, moving money into each account. Then I tallied
up all the bills and put them in the system.
A little bit of magic started to happen. I became less and less reactive about bills.
I didn’t immediately look at the bank account when I got a big bill and wonder
why I spent so much, and when I could pay this one off. Instead I started to feel
more in control. By looking at my bills and my deposits two times a month, on
the same days each time, I could see a pattern. I noticed that 80% of my bills
were due at the beginning of the month, and that few were due in the second
half. And I saw how my deposits were pretty equally dispersed over the month.
I realized that I had many “small” recurring bills that added up to a lot of money
and were unnecessary expenses. I started to see trends and understand my cash
flow. I didn’t start to stack bills, paying what I could and then putting the ones I
didn’t pay back in a stack. I started to manage bills and cancel unnecessary stuff.
I started to pay bills on time. Every bill.
Liz Dobrinska, my graphics guru who designed my website and even the cover
of this book, told me, “I don’t know what happened, Mike, but you now pay on
time every time. I wish all my customers were like you.”
Before I started following Debra’s advice, I paid Liz inconsistently. Sometimes I
paid the bill the day it arrived. At other times, I sat on it for sixty or ninety days.
It wasn’t because I was trying to take advantage of her; I was simply in
reactionary mode. My method of bookkeeping was not an effective way to
understand my cash flow or to keep my critically important vendors happy. The
10/25 Rhythm changed all that.
Here’s how to get started:
1. Deposit all revenue into your Operating Expenses Account.
2. Every 10th and 25th day of the month, transfer the total deposits
from the prior two weeks to each of your “small plate” accounts based
on your current allocation percentages. For example, let’s say you
have $10,000 in total deposits for the past two weeks. Based on the
following example percentages, here’s how you would allocate the
$10,000:
Operating Expenses 43% - $4,300 Tax 15% - $1,500
Owner’s Pay 30% - $3,000
Profit 12% - $1,200
Employee Pay ($750) - $0
Petty Cash ($50) - $0
3. Transfer the specific dollar amounts from the Operating Expenses
Account to respective accounts. In this example, Employee Pay for
$750 and Petty Cash for $50. The accounts will now look like:
Operating Expenses 43% - $3,500
Tax 15% - $1,500
Owner’s Pay 30% - $3,000
Profit 12% - $1,200
Employee Pay ($750) - $750
Petty Cash ($50) - $50
4. Transfer the full account balances for both your Tax and Profit
Accounts to the respective “no temptation” accounts at your second
bank.
5. You have $3,000 in the Owner’s Pay Account from which to pay
yourself. Take only what you have allocated as your biweekly salary,
and leave the rest to accumulate. For this example, we’ll say your
biweekly salary is $2,750. This would leave $250 in the account.
6. Pay your employees from the Employee Pay Account. For example,
if you pay $675 this pay period, it would leave $75 in the account.
7. With the remaining $3,500 in the Operating Expenses Account, pay
your bills.
Once you’ve done all that, the accounts would look like this:
Operating Expenses 43% - $50
Tax 15% - $0
Owner’s Pay 30% - $250
Profit 12% - $0
Employee Pay ($750) - $75
Petty Cash ($50) - $50
Profit and Tax money will be accumulating at your “no temptation” second
bank. As new deposits come in, you will deposit them in the Operating Expenses
Account, and on every future 10th and 25th you will repeat these same seven
steps.
A big note here: There is a strong possibility that you will not have enough
money in your accounts to do all this. If so, you’ve got a major wake-up call.
When you don’t have enough money left over to pay your bills, it is your
business screaming at the top of its lungs, warning you that you can’t afford the
bills you are incurring. You are spending more money than your business can
support. But don’t panic. Later in the book I detail a process that will help you
adjust to the 10/25 Rhythm as comfortably as possible. Even if you can’t pay
everything on the 10th and 25th, you must get into this rhythm, because it will
allow you to get a sense for the flow and accumulation of money. A heart fills
with blood and pumps it out, forming a heartbeat. The lifeblood of your business
is money; it should flow in a rhythm like a heart, not in a random, panicked
pump here and there when you have money.
QUARTER ONE
QUARTERLY DISTRIBUTION
The new quarter has arrived. Yippee! You are about to take your very first ever
quarterly distribution check. That’s right, baby. Your business is serving you,
now. You are going to take a distribution check every quarter. Every ninety
days, profit will be shared to you. This is where your Frankenstein monster starts
to become a powerful, lovable beast and serves you a fine meal on a silver
platter with a perfectly matched California Pinot Noir. Don’t you just want to
pinch those chubby cheeks?
The quarters of every year are as follows:
Quarter 1 – Jan 1 to March 31
Quarter 2 – April 1 to June 30
Quarter 3 – July 1 to September 31
Quarter 4 – Oct 1 to December 31
(This assumes your fiscal year is the same as the calendar year. If you have a
funky fiscal year, like if your year-end is May 31st, then your quarters will be
different.)
On the first day of each new quarter (or the first business day after), you will
take a profit distribution. Remember, the Profit Account serves a few purposes:
1. Cash reserves.
2. Metric to measure growth.
3. Profit.
Tally the total amount of profit in the account (don’t add any quarterly
distributions percentages from deposits you received this day, yet) and take 50%
of the money as profit. The other half remains in the account, as a reserve.
No matter what day you start doing Profit First, take a distribution for the current
quarter on the first day of the new quarter. For example, let’s say you decide to
implement Profit First on August 12th. You allocate to your multiple accounts
from that day forward. Then, on October 1st, or the first day of the new quarter
that you do your bookkeeping, you distribute the profit in the Profit Account.
Whether you start this process on July 3rd or September 31st, the next quarter
still begins as of October 1st; so you distribute profits for the prior quarter that
day. It doesn’t matter when you start doing Profit First; what matters is that you
get into a quarterly rhythm.
Welcome to the big leagues. You will now take a distribution every quarter, just
like large public companies do. They announce their quarterly income and then
distribute a portion of the profits to shareholders. And that’s exactly what you
are going to do (see, you are all grown up now). Quarterly is a great rhythm, by
the way. It is a long enough time between distributions that you start looking
forward to them, anticipating them. But it isn’t so frequent that they come to feel
like a normal part of your personal income.
Every quarter, you will take 50% of what is in the account, and leave 50% alone.
For example, let’s say you have saved $5000 in your Profit Account during the
first quarter of implementing Profit First. On the first day of the new quarter, you
will take $2500 as a distribution to the equity owners and leave the other 50%
intact.
If your company has multiple owners, the distributed profit is divided up based
on the percentage owned by each equity owner. Following the above scenario, if
you own 60% of the company, another partner owns 35% and an angel investor
owns 5%, the distribution would be $1500 (for you, the 60% owner), $875 (for
the 35% guy) and $125 (for the investor).
The key is this: The profit distribution may never go back to the company. You
can’t use a fancy term like “plowback” or “profit retention.” No term you use
will cover up the fact that you are stealing from Paul to pay Peter.
Your business must run on the money it generates for its operating expenses.
The plowback of profits means you aren’t operating efficiently enough to run on
the operating expenses. And if you give the profit back, you won’t experience
the very important reward of your company serving you. You’ll just be letting
the monster loose again. So always take your profit, every quarter, and use it for
your own purposes. It’s celebration time!
CELEBRATION TIME!
When you take your profit distribution, the money is only to be used for one
purpose: for your personal benefit. Maybe you go out for a nice dinner with your
family. Maybe you get that awesome new couch you have your eye on. Maybe
you go on a dream vacation.
In the four years since Jorge and Jose started implementing Profit First in their
business, they have taken several dream vacations— Bermuda, Europe, cruises
—and have given those vacations to their loved ones as well. These guys know
how to celebrate!
“Before we started using Profit First in our business, we were a little bit lost and
wondered when the business would take off and improve our lifestyle,” Jorge
told me. “I don’t think anyone wants to work just for the paycheck. You need
more incentive. Now, at the end of the quarter, we really look forward to
planning what we’re going to do with the extra money.”
Whatever it is, you must use your profits on you! Why? Because this is how you
turn Frankenstein, that cash-eating monster, into a cash cow that keeps giving to
you and supporting you. Every quarter, with every profit you celebrate, you will
fall more and more in love with your business.
PAY UNCLE SAM
Every quarter, you will also pay your quarterly estimated tax. Your accountant
probably gave you estimates of how much you owe in taxes; now you pay them.
You will reduce some of the pain you feel when paying estimates, because on
this very same day each quarter, you also will take that profit for yourself, above
and beyond your salary.
ONE SMALL STEP
Each quarter, you need to evaluate your current percentages and move them
closer to your TAPs. You can move any percentage you choose to get to your
TAPs, but know this—the goal is to never take a step back. I would much rather
you take a small step closer to your target Profit Percentage than take a big leap
toward it, only to step it back a month later.
If you are adjusting and tweaking your percentages conservatively, I suggest that
you account for three percentage points each quarter. That is, you could move
your Profit Account from 5% to 8%. Or you could move your Tax Account from
11% to 12%, your Profit Account from 5% to 6% and your Owner’s Pay
Account from 23% to 24%.
If you can adjust further, go for it, by all means. Just remember, you can’t “undo
your percentages,” because that will undermine this new habit you have
established. And don’t forget: at the start of next quarter, you will be doing this
all over again. Think about what you’re doing for a second. You are now
distributing profits quarterly, which forces you to find ways to operate more
efficiently. Isn’t that friggin’ cool? Your little company is now doing the same
thing as the big kahunas in the industry. While Bloomberg Radio babbles on
about “higher than expected” quarterly profits and shareholder distribution by
such-and-such public company, you can smile and feel pity for the public stock
shareholders and the measly portions they get because you own a lot of stock in
your company. Oh man, does that feel good.
YEAR ONE
FINALIZE YOUR TAXES
Since you’re in the quarterly rhythm of evaluating and moving closer to your
TAPs, celebrating your profit disbursement and reassessing your expenses, there
isn’t much of anything special you need to do on a yearly basis. The only thing
you need to add to your financial management at year-end is the finalization of
your taxes.
Determine how much you owe and how far off you were in your estimates. If
you owe more than you have in your tax account, a few things likely went
wrong. You probably didn’t save a big enough percentage in your tax account,
and/or you didn’t check in quarterly with your accountant to see how you were
doing throughout the year with your tax reserve.
If you owe taxes at year-end and don’t have the money in your tax account, this
is the one time you can pull from your Profit Account for a reason other than
profit distribution. In fact, you have to. You won’t go to jail if you don’t have
profits to distribute to the owners, but you will go to jail if you don’t pay your
taxes. In this instance, pull the money you have from your Tax Account and your
Profit Account to pay the taxes. Then adjust percentages in your Tax Account to
ensure you will have enough for the next year.
When you adjust your tax percentage, reduce your profit percentage by that
amount. Yes, you are taking a hit on profits, but next quarter you will work on
getting those profits up again. The key now is to make sure you are fully
prepared for taxes.
If you have too much money left in your Tax Account, congratulations—you can
move that money to your Profit Account and take a profit distribution. You may
also be able to reduce your Tax TAP and increase your profit allocation
percentage by that amount. Just check with your financial expert first.
RAINY DAY FUND
As your profits accumulate in your Profit Account, and you only take half as a
profit distribution, the remainder will act as a rainy day fund. You sort of
become your own bank. This is a good thing, but too much cash on hand can be
a liability (people like to sue deep pockets); and money should be invested, not
allowed to sit and stagnate month after month and year after year. This is a
simple analysis of what to do with your rainy day fund. First accumulate a threemonth cash reserve for your business, so you have enough cash saved to operate
unscathed for three months if all sales came to a screeching halt and not another
penny came into the business. Then, when you see that the money in your Profit
Account is in excess of a three-month reserve, you know this is a good
opportunity to put money back into the business, to make some appropriate
capital investments that will bring a lot more growth and a lot more profit, or to
fund The Vault Account (that’s a little teaser for what you will be learning in a
little bit).
FOREVER
The Instant Assessment gave you the TAPs, but you can do better. Like an
athlete assessing her performance over time, as you use the Profit First system,
you will get a good sense of when and where you can push aspects of your
business to the next, world-class level. If you can, push for 22% profit, or higher,
or cut expenses down to 15%.
Even with you, and all the financial folks who help you in your business,
following Profit First, you’re still not finished. You can get every single person
in your business, regardless of what they do, supporting the business with Profit
First. They will do it by implementing a new type of to-do list.
In my second book, The Pumpkin Plan, I explain colossal seed-to-business
growth—the intersection of uniqueness, top customer demand and systems.
Your uniqueness (unique offering) is what makes money, but that only happens
when your top customers want your offering. If you can deliver it to them on
automatic, you have the potential to become a colossal force in your industry.
These three factors form a new, better way to create and maintain a to-do list.
You will use three symbols: a $ (dollar sign), a ☺ (smiley face) and an ∞
(infinity symbol).
From today forward, your team can quickly determine their most profitable
tasks. If something will likely make money for the company within the next
sixty days, give it a $. If it is something for a top client, give it a smiley face ☺;
and if it is a system that can be created so that other people or things can do the
task perfectly and you no longer need to do it, give it a ∞.
Next, write down the tasks you have. Code each of them with no symbol (if it
doesn’t apply to the three categories above), or one of the symbols above. In
some cases, a task will get two symbols or all three. Then prioritize your to-do
list based upon the symbols in this order:
First do $ ☺ ∞ These are God’s gifts to tasks. When you do one of these, you
will make money, make a client happy (which, by the way, is the most powerful
form of marketing) and systematize the task as a repeatable process. That way,
the next time this task presents itself, you just hand it off and it will be done
perfectly! Profit with a client loving it, and you will be able to do this on
automatic going forward.
Next is $ ☺ Happy client paying you money = a happy life. Then $ ∞ This is a
task that lets you make money and develop a system to make it happen
automatically. Maybe not for the current client, but automatic money usually
means new clients down the road.
Then do ☺ ∞ This is a task that makes a client happy. You will develop a
system so that it happens on automatic. Consider it automatic client retention
and automatic marketing.
Then do $ This task means you are bringing in money. Profit, baby!
Next, do ☺ You might not make money immediately by performing this task,
but a happy client is key to sustainability, is powerful marketing and usually
leads to more money in the future.
Then do ∞ With this task, you build a system so that you don’t have to do it
anew every time.
And lastly, do “ ” That is a blank. I just put the air quotes there so you could see
it was blank. In many cases, as you think of tasks and write them down, you will
notice that most are blanks—they don’t or won’t make money in the near future,
they don’t serve clients and they aren’t building systems. Do these things last.
By having everyone at your company prioritize their to-do lists with this simple
system, you push Profit First. Don’t just give this to-do system to a few people.
Share it with your entire staff. Help them focus on the three things that matter
most: profit (the lifeblood of your business, without which you can’t sustain the
business), clients (the real boss; without them there is no business); and systems
(the only way you can grow and compete).
•••
Jorge and Jose are living the American dream. Just ask them— they’ll tell you
they are most definitely living the life they set out to experience when they first
opened the doors of Specialized ECU Repair. If you follow the steps outlined in
this book, you too will look back on your first Profit First year with awe and
appreciation. You’ll be living the dream, baby!
ACTION STEPS
GET READY FOR A GREAT YEAR
Step 1: Go back to the beginning of the chapter and complete all of the “Day
One” tasks outlined there: notify your accountant, set up your accounts (if you
haven’t done so already), and make your first Profit Account deposit or transfer.
Step 2: Start a “celebration list”: come up with ideas for how you to spend your
quarterly owner’s distribution. Include small treats and big indulgences. Post the
list where you can see it, for inspiration and motivation and as a reminder when
the quarter comes around and you convince yourself there are more practical
uses for the money.
Step 3: Based on the system I shared in this chapter, revamp your to-do list and
start using it immediately. You can download blank Profit First To-Do forms at
—you guessed it—the Resources tab at MikeMichalowicz.com.
CHAPTER SIX: Destroying Debt
Well-dressed poverty is still poverty. Just because your business is making lots
of money doesn’t mean you’re hanging onto it. Too many entrepreneurs believe
that the top line is what defines success and then behave accordingly. Another
big client comes on board, and the entrepreneur expands the office. A big sale
rolls in, and with it a fancy dinner. It’s like putting Frankenstein’s monster in a
tuxedo and having it dance and sing to “Puttin’ On the Ritz” (shout-out to Mel
Brooks). The monster may look as if it has its act together, but it doesn’t. One
tiny bit of faulty wiring—like, the big client decides not to pay its bills—and the
monster goes on a rampage. Everything falls apart.
Two years ago, my cell phone rang with a call from my friend Pete. I was
expecting the call—we had plans to have dinner in New York City that weekend
and, since Pete is a resident of The Big Apple, he knows all the hot spots. I
figured he was calling to confirm plans. The call was not what I expected.
“I’m sorry Mike, I can’t do dinner this weekend,” Pete said, his voice strained.
“Damn, that sucks. I was really looking forward to it. But no problem, brother.
Let’s reschedule,” I said, looking at my calendar. “What’s going on? Heading
out of town?”
“Yeah, kinda. Well, not really,” Pete replied. Then he sighed and said, “I, uh…
I’m broke, Mike. I’m broke.”
Pete explained that his bank had called his line. I’m not sure if you’re familiar
with this experience, but here’s how it works: You get a revolving line of credit
from the bank. It’s a bank account that functions like a credit card, in that you
can draw as much money from it as you want, up to your credit limit, and pay it
back over time. As long as you pay your interest and make your minimum
percentage payment every month, you’re good.
Except there’s this pesky little rule in the fine print that says the bank can call
back the entire loan at any time. Even if you’ve paid your monthly percentage on
time every month, even if you’re not carrying a high balance, the bank can yank
your line of credit without warning. And once the bank calls to notify you that
they’re calling your line, the clock starts ticking. You have thirty days to pay
back every single penny. Tick. Tick. Tick.
Pete got the call. His line? A million bucks. The amount he had drawn from the
line? A million bucks. The amount in his company’s cash reserves that he could
tap into? Zero. Needless to say, dinner in Manhattan was off.
Struggling to get the words out, Pete said, “Mike, can you help me? I’ll follow
your lead. I’ll do anything. If you told me to run naked in the streets, I’d do it.”
Of course I agreed to help him find a way to dig himself out of this massive debt.
A Lady Godiva-like naked romp through the streets of New York might get him
some attention and give me enough razzing fodder for years to come, but it
surely wouldn’t address his debt (in fact it would probably add to it, what with
the fine for lewd and lascivious behavior). So we spent two hours on the phone
that night, going over Profit First in detail. At first Pete was confused—why was
I talking about profit when he was so far in the hole? You may be feeling this
way, too. I get it. It’s awfully hard to think about profit, let alone plan for it,
when your situation is as dire as Pete’s. You may not have a million dollars in
debt, but I’ll bet that whatever debt you’re carrying feels like it might as well be
a million dollars, at times.
This is the ultimate survival moment. If you focus all of your energy on paying
down debt, that is all you will ever achieve. You’ll still be caught in the trap of
top line thinking, which will likely result in more debt.
Again, there are similarities here to weight loss. If you’re overweight, at a
certain point your “credit line” will be called. Maybe you’ll see yourself in a
family photo and realize you can no longer say it’s “just a bit of a muffin top,”
because that muffin top is dropping down to your knees and tickling your toes.
Maybe one day you’ll get tired of always being tired. Or maybe it will be
something much worse—like a heart attack or diabetes—that finally moves you
to say, “Enough is enough.”
We can trace almost every major change to a pivotal moment when the pain of
staying a certain way is greater than the effort to make awareness of it go away.
Call it a tipping point or a turning point, a revelation or a wake-up call; whatever
name you give it, the choice is the same. Will you fix the crisis or the root of the
problem?
When life “calls the line,” we take action. The problem is, most of the time the
action we take is a reaction, a narrow, driving focus on the alleviation of
immediate pain. We move heaven and earth to bail ourselves out of a jam with
little thought of creating permanent change. Why do so many people who have
lost weight gain it all back (and then some)? Because as soon as they reach their
goal, they revert to old habits. Sure, no one wants to drink a gallon of water and
eat grapefruit every morning for the rest of their lives, or spend so much time
with the Thighmaster that they’re going to have to think about going steady with
it. The pain of being fat is gone—what’s the point of taking another Richard
Simmon’s Cruise to Lose?
Once the pain is gone, the action we decided to take in that pivotal moment falls
away. No more grapefruit. No more water. No more Thighmaster. Grapefruit is
replaced with grape jellybeans. Water turns to soda. And the Thighmaster is
tossed into the basement where all good intentions go to die. Is it any wonder
that when the weight comes back, it’s with a vengeance? After all, your mind
now knows you can lose weight in a pinch. Who cares if you gain a few pounds?
You can always crash diet again, right? Try out for The Biggest Loser? And of
course there’s always “the surgery.”
What my friend Pete intended to do was the same deal, different crisis. He had
had the equivalent of a financial heart attack. As soon as his big moment hit, he
became a man on a mission—crush that debt immediately! By whatever means
necessary, he would dig himself out of the crisis. His actions (or reactions) were
the equivalent of a crash diet. He wasn’t giving any thought to how to make his
business permanently healthy.
If Pete manages to survive this crisis in crash diet mode, what are the chances he
will find himself in a similar situation—or worse—a few months or years from
now? The chances are high—so high I would say it’s a sure bet.
Even when you and your business are in debt up to your eyeballs, you must
establish a habit of putting your profit first. You must still (and always) pay
yourself first. When you get into the habit of fiscal health based on this system,
you will fix the problem permanently. Financial crises will be a thing of the past,
because if someone calls your line, you’ll have the cash to cover it.
Here is what I told Pete: “If you have debt, be it one thousand, one million or
somewhere in between, you need to kill that debt once and for all while still
slowly and methodically building profit.”
The Profit First system I’m teaching you will keep your focus on a super-healthy
business, working in your sweet spot to produce goods and provide services for
ideal clients. This laser focus will automatically keep your costs down, allowing
you to pay off debt faster and eventually increase your Profit Percentage. The
tweak is, when you distribute profits, ninety-nine percent of the money goes to
paying down debt. The remaining one percent goes toward rewarding yourself.
This way, the debt gets hit just as aggressively, but you still strengthen your
Profit First habit.
In short, if you wait to implement Profit First until after you pay down your debt,
you are less likely to ever build the business efficiencies that will permanently
eradicate your debt and create a perpetual profit stream. Start the habit now, and
eventually that ninety-nine percent will go toward building up your cash reserves
and your own owner distribution.
ANOTHER SIMPLE SOLUTION MOST PEOPLE DON’T BELIEVE
ACTUALLY WORKS
By now I hope you’re a member of the “How healthy is your business?” club.
Are you wearing the t-shirt? I am. What? Don’t have one? Don’t know where to
get your own? I’ll give you a hint—it’s in your closet. Sharpie, old t-shirt,
“Profit First” on the front, “How healthy is your business?” on the back. Ten
seconds. Done. What? Did you think I was going to give you a link to my online
store? Hardly. A profitable business happens when you save your pennies at
every turn, my friend. That’s how we club members roll. Frugal. Not cheap, but
frugal, for sure. And that is how I ended up with the homemade masterpiece I’m
currently sporting—and a healthy cash reserve that is about to send my family
and me on a nice vacation, where I will wear my awesome t-shirt with pride,
thank you very much!
Getting that healthy business all boils down to one really, really simple formula:
You must consistently spend less money than you make.
Duh, right? I’m sure you knew that. Everyone knows that. So why do so few
people follow it? Spending less than you make every day, every week, every
month, every year, every decade leads to wealth and freedom from financial
stress. And yet most of us can’t seem to do this one simple thing.
Here again we’re talking logic versus human behavior. If logic worked for us
humans, we’d all be rich. I wouldn’t be writing this book to tell you how to do
this, because you would already be doing it. Instead, I would have one of my
minions swim from my big yacht over to your even bigger yacht to ask if you
could spare some Grey Poupon. Then we would both chuckle at the complete
absurdity of the situation. I mean, who would have the audacity to eat anything
with a common man’s mustard like Grey Poupon?
This is the challenge all of humanity faces: We know what we have to do, but
we still don’t do it. Why is that? Why do so many of us consistently fail to
become rich and accumulate debt instead? Why? Why? (Picture me on my knees,
dramatically banging my fist on the ground and shouting, “Why, why?” like
Scarlett O’Hara in Gone with the Wind.)
Fortunately for us, Suze Orman has the answer.
Now, let me say something about Ms. Orman. I am a huge fan. However, I have
never watched her show on CNN and, aside from one book (which I still haven’t
read in its entirety), I have not purchased any of her products. I’m a fan of hers
because I saw a lecture she gave on PBS one Sunday morning.
I like to write early on Sunday mornings, when all is quiet in the house. But on
this particular morning I decided to brew a pot of coffee and channel surf
instead. Thank God I did. As I flipped through the channels, I saw Suze Orman
talking to a group of about fifty people. I had heard of her and seen her picture a
million times, and I was curious to see how she presented in a public speaking
format. Maybe I could glean some tips and tricks on being a better presenter.
And let me tell you, she is really good. I have seen hundreds of speakers, and she
truly impressed the heck out of me.
While explaining personal financial strategy to the audience she stopped, looked
around the room and said, “The solution to debt is this simple: If you want to get
out of debt, you must get more enjoyment out of saving your money than you do
spending your money.”
This was a life-changing realization for me. I put down my coffee and stared out
the window. Suze continued to speak, but I was so caught up in my a-ha
moment, I heard nothing. I just kept repeating what she said about saving versus
spending over and over in my head. “That’s it,” I thought. Wealth is a game of
emotion. Business success is a game of emotion. Profit First is a game of
emotion. It all comes down to the story we tell ourselves about what we’re
doing. “Is what I’m doing making me happy, or not?”
When something makes you happy in the moment, you’ll keep doing it. If
spending makes you happy, you’ll spend more. Period. And that spending can be
on anything from a new tie to a new hire to new mountains of debt. If saving
makes you happy, you’ll look for any opportunity to save more. Coupons, sales,
bargain bins—heaven. Saving one hundred percent because you eliminated the
expense entirely? Nirvana.
Listening to Suze that day, the whole “pain and pleasure” motivation that
Anthony Robbins has talked about for years finally made sense to me. The pain
moment is the kick in the ass, when you finally say enough is enough. Pain gives
you a big shove out the door. For me, the pain moment was my daughter sliding
her piggy bank toward me, trying to save our family from absolute financial
ruin. For Pete, it was a call from the bank.
But pain just gets you to take enough action to get out of immediate pain. Then it
stops working. Suze was teaching me the other half: pleasure. (Don’t do it. Don’t
let your mind go there. And… there it went. Keep reading when you get your
mind out of the gutter, pervert. I’ll wait.)
The premise is simple—we avoid pain and move toward pleasure, putting a
significant emphasis on the moment (remember the Recency Effect) and very
little emphasis on the long term. Immediate pain gets the ball rolling, but
pleasure keeps it moving. You probably picked up this book because of pain,
and you will likely see results quickly because your efforts will reduce the pain.
But the only way you will be able to make this work forever is if you get
immediate pleasure each time you exercise your new habits. Just as at the gym,
you can only work out so many times before the pain of seeing your muffin top
in the mirror isn’t worth all the effort anymore… and it is at that exact moment
that you most need to derive true joy from working out, because it is what will
help keep you fit and trim forever.
If you are stuck in the grow-more/spend-more mode and accumulating debt, it
isn’t because you don’t understand the numbers. You are absolutely not an idiot.
The problem is assuredly linked to your emotions. You are getting instant—
albeit momentary—pain relief, because your mind believes that your investment
will bring results (the hope of future and permanent returns). When this doesn’t
happen, you slip back into panic, sell like a mad dog and spend (more often
using the friendly term “invest”) to grow. You find momentary pain relief in
making some type of progress. But when it fails to yield more cash in your
pocket, the pain comes back. It’s a nasty cycle.
Fortunately, the fix is simple, if you allow it to be: Give yourself more joy when
you choose not to spend money than you do when you choose to spend it. Give
yourself more joy when your bottom line grows (not just the top line). Give
yourself tons of joy when your Profit Percentage grows.
You do this by acknowledging it to yourself. I don’t care if you feel like Stuart
Smalley giving yourself a pep talk in the mirror; you must train your mind to
find joy in implementing the Profit First system. (One of the best ways to find
joy in this is to hang out with other Profit First entrepreneurs. Everything is more
fun when you share the experience with others. I’ll talk more about this in
Chapter 8, when I teach you how to participate in an accountability group—a
Profit Accelerator Group or Profit Pod.)
When you opt not to spend money, acknowledge it. Give yourself a pat on the
back. Do a happy dance. Celebrate every time you save— whether it’s ten bucks
or ten thousand. Put on your favorite music and crank it, get really happy.
Embarrass your kids at the mall. Heck, embarrass yourself. Don your new Profit
First Sharpie t-shirt, sans trousers, and post that one on Facebook. Over time you
will train your mind to equate happiness and celebration with choosing saving
money over spending it (and perhaps walking around malls in a t-shirt and
tighty-whities).
It’s hard to get by without food or water, and toilet paper is a really handy thing
to have. When you do have to spend money, reward yourself for getting the best
deal possible. Find a good price for the essential things you need and don’t buy
the nonessentials. Then start the t-shirt celebration all over again.
THE “JUST ONE MORE DAY” GAME
Remember the story about how I lost my first fortune by becoming the Angel of
Death? You might remember that, in the end, all but one of the companies I
invested in went belly up. The lone survivor was Hedgehog Leatherworks. The
owner, Paul Scheiter, is an amazing guy. I consider him my best friend. I shared
some of the success strategies we employ at Hedgehog in The Toilet Paper
Entrepreneur and The Pumpkin Plan, so if you read those books then Paul
probably seems like your best friend, too.
Recently I went to visit Paul at his place in St. Louis, Missouri. As we drove by
a Home Depot on the way to his leather shop, he said, “Oh, I need to get some
electrical stuff for the office.”
Then he smiled and kept driving. “Why don’t we pick it up?” I asked.
“I will,” he replied. “In just one more day.”
The next day we drove by the same Home Depot. Paul looked at the sign,
grinned from ear to ear, then looked away and drove on.
I said, “Don’t we need the electrical supplies?” “Absolutely we do. Just one
more day.”
This pattern went on for the entire week. At the end of my visit, Paul drove me
to the airport. Just before we pulled up to my drop-off point, I asked him why he
hadn’t yet bought the electrical supplies he needed. That’s when he shared his
“Just One More Day” technique. I had some time before my flight, so we pulled
over to short-term parking. During the next half hour, he laid it all out for me.
Paul understands the formula, spend less + make more = wealth. He also
understands that for this formula to work, both factors in the equation must
provide him with an emotional win.
It’s easy to feel happy about making more money, but to achieve real wealth you
also have to train yourself to feel happy when you spend less. Paul achieves this
by rewriting the formula in his mind. His version is (+spend less) + (+make
more) = wealth. In Paul’s formula both spending less and making more are
positives. Not surprisingly, his formula is like the Profit First Formula; it
prioritizes human behavior, not logic.
When Paul needs to purchase something, he plays the “Just One More Day”
game. He challenges himself to go just one more day without the item. Every
time he passes up an opportunity to buy whatever he needs, he gets pumped. He
gets a high from going without for one more day. Sometimes, while playing this
game, Paul discovers that he no longer needs the product or service he intended
to buy. Playing the game opens up other possibilities, and truly tests how badly
you need something. Sometimes you can’t get around it—you have to spend
money on something because you actually need it. But by waiting “just one more
day,” you are not only keeping operating cash in your account for one more day;
you are giving yourself another day to come up with alternatives.
THE WORST MONTH
If you’re like most entrepreneurs, your personal income is wildly unpredictable.
It changes month by month, depending on sales and collections. We’re a hopeful
bunch, entrepreneurs—we have to have the nerve to launch a business in the first
place. So it’s no surprise that most entrepreneurs are bamboozled by their hopes
and look at their best revenue months as the new normal, when very often it is
not. Until your best month becomes your average month, it’s not the norm; it’s
the exception.
When you base decisions on your best revenue month, you will run out of cash
—quickly. Debt will start to pile up. And you will go back to your old standby,
“sell more—grow, grow, grow!” Acting as if your best month is the norm is one
surefire way to keep yourself locked in the Survival Trap.
In fact, accountants joke about this. I had a call with Andrew Hill and Gary
Nunn, the founders of Solutions Tax & Bookkeeping in Frisco, Texas, about the
spending habits of entrepreneurs, and they told me the inside joke. Whenever a
client approaches them about a windfall of new money, the client will inevitably
say, “I don’t even know how I would ever spend all this money.”
Each time, Andrew and Gary have the same response: “Oh, you’ll find a way.
And you’ll probably figure it out within the next month.” Maybe that insiders’
joke isn’t ROTFLMAO (Rolling On The Floor, Laughing My Ass Off) funny to
you, but it is to Andrew and Gary. They hear the same comments from
entrepreneurs all the time, and in every case, by the next month, the money is
gone.
Every. Time.
That’s why percentages are such a valuable tool. As an entrepreneur, your
income varies. Some months are great; some months suck; and most are average.
But it is typical behavior for entrepreneurs to look at their best month and tell
themselves, “This is my new normal”— and then start spending and taking from
the business accordingly.
Percentages are based on real results—the cash in the bank. No games, no
hypotheticals, no, “We’ll make it up next month.” Projections are an opinion.
Cash is a fact.
The percentages put a varying sum of money into your different accounts, such
as Owner’s Pay, every 10th and 25th; and then you draw your owner’s salary
from that account based on the pay you allotted. If you have more money in the
account then you take in salary, the difference in money stays and accumulates.
This way, when (notice I didn’t say if) a slow month happens, money has
accumulated in your Owner’s Pay Account and your salary stays consistent. If
the money in the Owner’s Pay Account is not enough to pay your salary, you
can’t take it. You need to make a hard decision about cutting other costs, and
you’d better kick ass growing the top line with great clients, too.
So how do you predict the owner’s salary your company will likely support?
Look at your slowest three months and average them. That is the lowest your
revenue will likely ever go. Then determine the percentage of this income that
will be allocated to Owner’s Pay (35% for example, times the average monthly
revenue for the three worst months). Every quarter, we will do a salary raise
based on how much money is in the Owner’s Pay Account and whether it is
accumulating faster than we are withdrawing it. Take the bump that you can
reasonably take based upon your twelve-month, rolling average. As long as the
account accumulates more cash or stays even, you are taking a healthy salary
(one that your company can healthily support).
THE DEBT FREEZE
I’ve taught you how to ensure your business is profitable immediately— from
your very next deposit. Now I’m going to teach you how to immediately stop
accumulating debt, and to destroy the debt you currently have. I call the method
you are about to learn the “Debt Freeze.” It will guide your business through a
rapid pay-down of accumulated debt and a freeze of new debt, both while
continuing your Profit First habit.
Now, don’t panic. I’m not asking you to sell everything and move into a van
down by the river. I’m not even asking you to stop spending entirely. That can
irreparably damage your business. I am simply asking you to commit to a
spending freeze that will free you from debilitating debt. The goal here is to cut
cost, not to compromise the business. You can fire all your people, shut down
your website, refuse to pay a penny to anyone and seriously move into a van
down by the river with your new roommate and struggling motivational speaker,
Matt Foley. . . but you’ll be out of business. You want to cut out the fat of your
business, the stuff that is not generating or supporting income for your company.
But you don’t want to cut out the muscle, the stuff that you absolutely must have
to deliver your product or service.
You need to know where you stand. The first step is to assess where you are
today. Fear is only amplified by a lack of knowledge. If you don’t know your
exact numbers, your mind goes wild and says crazy things (like. . . “Ahh. . . I am
going broke. . . ahh. . . the only thing worse is Mike dressed up like Scarlett
O’Hara. Ahh. . . what the hell am I thinking? Ahh!”). You can’t change what
you don’t acknowledge, so you need to know exactly what you’re dealing with.
And when you know what you are dealing with, your mind doesn’t drift nearly
as much.
For those of us who get happy when we save (remember Suze’s speech?), the
Debt Freeze is a rave party. To be clear, this is my kind of party, and I’m a freak.
When you see the crazy debt-reduction fun we have planned, you might want to
back out the front door as quickly as possible. But, if you want to be debt free
forever, stick around. Here are the steps to getting your party started:
PRINT AND MARKUP DOCS
1. Print out your current income statement for the last twelve months,
as well as your current accounts payable report, your credit card
statements, loan statements and any other statements related to debt,
and your last twelve months of payments made from any of your
business bank accounts. If you do not have an income statement ready,
just gather the other documents.
2. With a highlighter, draw a box around any labor costs— salaries,
commissions and bonuses for employees. Exclude owner salaries
and payments to freelancers and subcontractors.
3. Now highlight expenses that were required to generate immediate
revenue. For example, if you are a private investigator, you might
highlight the purchase of a USB drive you use to store evidence that
you give to your clients. If you bought a USB drive that you do not
give to clients and just use internally, that item would not be
highlighted.
4. Next, highlight any expenses that are absolutely necessary to keep
your business open. This does not include employees or contractors, or
any people you boxed with your highlighter already in Step 3. If you
have a spy car that is outfitted for surveillance and you need it to—
well, spy—highlight it. If you have a spy car that really isn’t a spy car,
it’s just your ride, don’t highlight it.
5. With a red pen, circle expenses that repeat every month, quarter or
year and will continue to do so. Note: Some expense items, like labor
costs, will get highlighted or boxed and circled.
NOW LET’S DO SOME MATH
6. Add up all the expenses for the year; include everything you
highlighted, circled, boxed or left blank. Exclude tax payments and
owner’s distributions or salaries. Divide the result by twelve to
determine your monthly “nut”—the total amount you have decided
you need to cover each month.
7. Determine the difference between your current monthly operating
expenses and the number it must be according to your Instant
Assessment. For example, if you currently have $52,000 in average
monthly expenses and your Instant Assessment has your monthly
expenses at $30,000, you need to cut your operating expenses by
$22,000. Period. There will be no justifying past spending mistakes, no
saying, “But I need everything.” You don’t. Your healthy, booming
competitor has figured it out. You need to put on your big-girl panties
and accept that you spent too much, and today is the day we fix it.
(Kinda creepy that I know you wear big-girl panties, isn’t it?)
8. Band-Aids come off more easily when you tear them off. Chipping
away a little debt here and a little debt there prolongs the agony; rarely
fixes a company fast enough; never changes your behaviors to those
that truly put profit first; and is really, really scary for your employees.
Cutting back a few things (or people) at a time puts your employees
(and you) in a constant state of uncertainty. Ripping off the Band-Aid
will make you scream in pain momentarily, but the healing starts right
away. The same is true with debt.
To avoid having to keep chipping away at debt, it’s best to plan to cut
expenses until you are operating at 10% below the target number on
your Instant Assessment. So if we know we need to cut expenses down
to $30,000 to be in the Profit First range for operating expenses, we
want to do what we can to cut down to $27,000 (that extra 10%).
Why? Because when you cut expenses, you may realize that
something has a negative effect on your business, and you can’t
replace it with a timely alternative. You may need to take a few
expenses back on. I call this “expense bounce-back.” It happens—we
just need to prepare for it.
BUILD A LEANER TEAM
9. Labor cost is usually the most expensive part of operating any
business. This is the first expense you put a highlighted box around on
your income statement, and you almost definitely circled it in red pen,
too. If your company is racking up debt, it is all too often because
labor cost is too high. The problem with cutting labor cost is, our
minds quickly defend and justify why people should stay: “I own the
company;” “I can’t do the work;” “I need to direct my team to do the
work.” Plus, they need a job (which is true), they are integral to the
company (probably also true), the company will tank without them
(super unlikely), and if I get rid of them I won’t have people to do the
work (hardly ever true).
Overstaffed entrepreneurs have either tried to get themselves out of
doing work as quickly as possible (they like to think they are managers
now, or better yet, they need to spend extraordinary amounts of time
on the corporate “vision”) or believe that systems aren’t core to a
business (which they are). You need to let go of people. And you have
got to realize that switching from working in the business to on the
business is not like flipping a light switch. It is gradual. Often, the
most under-used employee in an overstaffed company is you, the
owner. It’s time you get back to actually doing the work, and in the
future we will slowly transition you from in to on.
Now, back to your overstaffed company. Evaluate each person and
determine if her role is mandatory for operations to continue (not the
person, but the role). If a person wears multiple hats (for example is
your receptionist and in-house sales person), ask yourself if each role
is mandatory for operations to continue.
10. Next, evaluate your staff. Are there any people who aren’t “Aplayers”? Do you have any people who are actually bad for the
company? Those people are costing you money in more ways than
one.
11. Ignoring the salaries and how you feel about the people, determine
the following: a) which roles must stay in-house no matter what, b)
which roles could be outsourced and c) which roles the company can
continue without.
12. Next, look at your people. Look at yourself. What roles could you
take on? Now look at your best employees, the A-players. Can they be
shifted around to cover the roles that must stay in-house? Are there
any must-have roles that can only be handled by a specific person?
13. Plan the layoffs. Now, before I get into this, I want you to know
that I know how devastating it is. I know how much you will want to
resist ever doing this, because I did. There was a day when I had to lay
off ten people out of my twenty-five-employee company. It was the
most difficult day of my professional life. I had to lay off nearly half
my staff, not because they did anything wrong, but because I did—I
mismanaged the numbers; I hired quickly and often and unnecessarily.
I also want you to know that no matter how devastating it is, laying
people off is necessary. Trying to keep a few employees your company
cannot afford will only put your company under, thereby ensuring that
everyone loses their job. And, because you prioritize the layoff of
poorly-performing staff and people who fill roles that are not a core
need for your company, you are not just saving the cost of keeping
these people on; you are also building a more efficient infrastructure.
Keep in mind that in letting these people go, you are freeing them to
find a job that is a better fit. Yes, it sucks that you need to fire the
people you hired on good faith. But it would be worse if you kept them
in a dead-end job. I know this firsthand. Just this morning I looked up
the LinkedIn profiles of the ten people I had to lay off that terrible day.
All of them have better jobs. Three are managing partners at
significant industry firms; another is living her lifelong dream of
sailing around the world; one is a now a judge; one is a stay-at-home
mom (which, my wife likes to remind me, is the ultimate job)! None of
this would have happened if they had stayed at my unprofitable little
company.
14. Call your employment and/or business attorney. (For a list of
lawyers who are also PFPs, go to MikeMichalowicz. com and check
out the Resources section.) These attorneys understand the law, will
review your employment agreements and make sure you handle your
layoffs properly. Never, and I mean never, proceed with terminations
or layoffs without talking with your attorney first.
15. Among the highlighted, boxed expenses, you also have
commissions and bonuses for employees, freelancers, etc. Look for
ways to cut down on or remove these costs entirely, but always
remember that in doing so, you are reducing someone’s pay. Staff or
freelancers handed a notice of reduction in income are likely become
disgruntled or disheartened; no matter how you deal with it, expect the
news to kill morale and weaken productivity.
16. Start the layoffs. Choose a second person (perhaps your business
partner, or your HR director, or, if you don’t have anyone in-house,
bring in your attorney—this is one of the few costs you do want to
incur) to witness the layoffs and help you explain the situation with
each employee. Meet with each person. With the approval of your
attorney, first explain the reason for the layoff to your employee and
then provide support that you can afford, like circulating his résumé or
even paying some severance.
17. Once each person is laid off, call a staff meeting with all your
remaining employees. Share what you have done and why you did it.
Explain how difficult it is to have to do this, and that you take
responsibility for both the financial problem you got the company into
and for fixing it. Assure your team that everyone remaining is here to
stay, and that you have taken action to immediately stabilize the
company.
Do not, I repeat do not, ask people to take a pay cut. I did this with dire
consequences. Asking all your people to continue to work just as hard or harder
than ever for less money is worse for the emotional welfare of your company
than letting just one more person go. When I did this, it disheartened the entire
team. I was simultaneously telling them to step up for the company and cover
their own work as well as that of the people who had left and that, as a reward
for their efforts, I would cut their salary by 10%! They felt disheartened and
fearful that the cuts would continue. Of the people remaining, nearly half of
them started looking for a new job with a more stable company. All of a sudden
there were a lot of sick days, and one of my key remaining guys decided not to
remain. He got a job elsewhere.
TIME FOR MORE CUTS
18. Now the hardest part is over, call your bank and tell them to stop
all automatic withdrawals from all of your accounts, except for any
that you have highlighted in Steps 2 and 3. Then notify your vendors
that you are stopping the withdrawals and will pay by check going
forward. I am not suggesting in any way that you should not pay what
you owe, or break a commitment. I simply want you to be acutely
aware of every payment you make.
19. Call each credit card company for which you have a card and ask
them to issue you a new card with a new number. Tell the credit card
company that no payments that were being processed on your old card
should transfer to your new one. (Many credit card companies do this
for you as a convenience, and this is a convenience that you do not
want.) You need to do this because your cards have been compromised
—by you. This step will stop all automatic charges. Then, just as you
did in the previous step, notify each vendor that you are putting a halt
to the automatic charges.
Those recurring fees can be insidious. I got trapped in a recurring gym
membership fee. I would see it on my credit card, and since it was “only $29” a
month, I let it go. I wasn’t going to the gym anymore, but I told myself, “I
should go to the gym. I’ll keep the charge because I’ll use it at some time this
month.”
Then one day my credit card was replaced because of suspicious activity. (I
wondered if my credit card company was suspicious about how I could be a gym
member for so long and a regular McDonald’s customer). The day the card was
canceled, the gym membership payment stopped. I had forgotten about the gym
membership entirely, and didn’t even notice the charge on my monthly bill.
When the gym called to get a replacement card, I canceled the membership. I got
curious about how long I had been auto-paying the gym. Turned out I had only
gone a total of six times over nearly seventeen months, which breaks down to six
hours of use for just under $500.
But the story doesn’t end here. This is when I realized I wasn’t working out
nearly enough, so I called some friends and started exercising with them. One of
them has a membership to the same gym and can bring a guest for free once a
week. Guess who goes with him? I am averaging fifty-plus workouts per year at
the same gym now, at no cost. And he is working out more, too, because he has
a motivated workout partner.
The point is this: Cutting costs is something that is very easy to put off for
another day. It’s the mañana syndrome—I’ll get to it tomorrow. And for me
(and you too, I suspect) those days of putting things off pile up to a year or more
very quickly. You will be unable to put off cutting costs anymore simply by
getting your credit cards reissued.
20. Cut every single circled red expense that you can. Recurring bills
are sneaky; they seem small and insignificant until you look at how
much you spend cumulatively, over time. To make this even clearer,
multiply a monthly recurring bill by twelve. That is what you are
really spending. Put a big “X” through each circled expense you
cancel. If you absolutely can’t get rid of a circled expense, highlight it
on the paper.
21. Renegotiate the highlighted expenses. Everything is up for
negotiation—your rent, your credit card rates and debt, your vendors’
bills, your software license, your Internet bill, your weight, your
height, your age, everything. Your job now is to contact every vendor
and get your costs reduced in the most significant way possible
without hurting the relationship. Your vendors will not typically be
happy with the suggestion of a 50% reduction, so I suggest you start
by asking for a 25% reduction in the hope of getting a 10% to 15%
savings. But don’t just call, do some research first. Find alternative,
less expensive providers and be prepared to go to the alternatives.
Start by negotiating the small, necessary expenses. You want to build
your negotiation muscle. Build your way up to the bigger expenses.
Negotiation is a whole topic of its own, but for now, realize that being
a hard-ass isn’t always the most effective approach. Being informed,
firm and willing to concede so both sides win is the best method. The
goal is to get the same results at a lower cost. It doesn’t mean that you
need to stick with what you have and get it more cheaply; you can also
find alternatives—a different thing, more cheaply. For example, some
hotels charge for Internet access in the room and others don’t. If you
can’t get a hotel to remove or reduce the in-room Internet charge, get
the lobby password and work there.
22. Put a big check mark next to each highlighted expense you
successfully negotiate or replace.
23. Now go through all those expenses that are left on the list. You
know, those that you left blank. It’s time to wipe them out. Put a big X
through each expense that you commit to not incurring again—at least
not for another two years. You are going to take a sabbatical from
these expenses and discover how much your business can accomplish
without unnecessary expenses.
Job done. And if you made it to your target expense reduction without going on
a bender, I say job well done. Breathe for a few moments. Feel the stress of
overwhelming expenses leaving you. This was a hard day, but by completing it
you have staged yourself for major profits. Now you’re ready to grow your
business in an efficient way.
Cutting costs is embarrassing. You have a reputation. You always pay for
dinner, or you drive the nice car. You are the “nice” boss who throws pizza
parties and gives sweet holiday bonuses. Let me assure you, the relief you feel
once you complete the Debt Freeze is way more powerful than the
embarrassment you fear.
No matter how much debt you have, know that there is a way out. More than
that, know that you are not the first person to be here. Many people have
recovered from dire financial situations and the key to doing that is in your
hands.
We are on a mission to change the perspective of successful business from
“make a lot” to “save a lot.” The new definition of success is not about the most
revenue, employees and office space but the most profit, generated through the
fewest employees and with the least-expensive office space. Make the game one
you win based upon efficiency, frugality and innovation, not on size, flair and
looks.
IF YOU OWE A BANK A MILLION DOLLARS
There is a saying in the banking industry: “If you owe a bank a thousand dollars,
it’s your problem. If you owe the bank a million dollars, it’s their problem.”
Remember Pete? After our call, he started a Profit Account, cut expenses like
mad and then called the bank. Almost everything is negotiable, and when you
owe a bank a million bucks and don’t have it, they’ll listen to your ideas. Pete
worked out a very doable payment plan, and within three months had already
whacked out 5% of the debt and turned a profit. And, he joined an accountability
group. Mine. We have been keeping each other in check for over two years now,
and while I am vowed to confidentiality about Pete’s progress, let me just say
this... it’s been massive. Pete was, understandably, a quivering wreck when he
called me that night two years ago. Today he is the epitome of confidence. And
Pete did it by implementing the power of small actions, a series of consistent
small steps bringing about big results.
LEAST EFFORT, BIGGEST RESULTS
You too must utilize the power of small actions. What is the biggest bang for the
buck with the least effort? When it comes to fixing things, we need to build
emotional momentum. Kinda like going to the gym. If you go back to the gym
for the first time in ten years and work out like a mad dog, you may feel great
that first day; but within a day or two, you will be so sore and in so much pain,
you will likely never go to the gym again. Momentum rarely occurs after one
crazy effort. Momentum builds slowly but relentlessly. Small, repetitive,
continuous actions, chained together, build momentous momentum (say that one
ten times fast).
In his extraordinary book, The Total Money Makeover, Dave Ramsey explains
the “Debt Snowball.” It’s contrary to logic, but plays exactly into the psyche of
all of us human beings. Ramsey tells us that logic would say to pay off our debts
with the highest interest rates first, but that doesn’t build emotional momentum.
It is getting to tear up a statement—any statement, because it is fully paid off—
that gives you a sense of momentum and gets you charged up to tackle the next
one. Ramsey explains that you should sort all your debts from smallest to
biggest, regardless of interest rates. Only when two debts are a similar amount
should the one with the highest interest rate be paid first.
Ramsey tells us to pay only the minimum on all the debts, except the one at the
top of the list—the smallest one. Then put all your financial power into crushing
that first debt as fast as possible. Once that first debt is wiped out, then tackle the
next one on the list by adding to the minimum payment with the money you
were using to pay the first debt. Once the second debt is paid off, go for the next,
adding all the money being used to pay the second debt to the minimum of the
third. See how the snowball grows? And see how your enthusiasm and
excitement about eradicating debt grows? You will get more and more pleasure
from not spending than you once did from spending. Suze and Dave would both
be so proud of you.
But the trick to Ramsey’s method, and Suze’s, and mine (and anyone with one
iota of sanity) is this: You cannot add new debt as you pay off old. That is just
shifting money around, paying down one debt while building another. You need
to get your Debt Freeze on. And then destroy debt, once and for all.
ACTION STEPS
DOWN WITH DEBT
Step 1: Start the Debt Freeze. Stop any recurring payments and kill off anything
you don’t need. Do whatever it takes to get your “monthly nut” down to 10%
lower than your Instant Assessment suggests it should be.
Step 2: Start the Debt Snowball. Pay off your smallest outstanding debt first. As
you wipe out each bill with recurring payments, use the freed-up money to tackle
the next smallest debt.
Bonus: Join the “How healthy is your business?” club. Make your Profit First tshirt and then post a selfie of you wearing that shirt on Facebook, Twitter or
Google+. Be sure to tag me when you do it.
CHAPTER SEVEN: Found Money
I have yet to meet an entrepreneur who hasn’t wanted to hire a “rainmaker”—
that magical salesperson who, like the companies that say they can give you
access to your great-grandmother Sally’s unclaimed fortune, will save the day by
bringing in big sale after big sale. Never mind the fact that we, the owners and
leaders who love our companies and what we do, are the ultimate rainmakers; it
is this top line approach to solving a cash flow crisis that holds companies back.
Cranking up the sales team in order to “make it rain” is not going to help your
company if you don’t have efficiencies in place, because ultimately, whatever
new client revenue you generate will have corresponding costs. And these are
likely to go unchecked.
If you want to increase profitability (and you’d better friggin’ want to do that),
you must first build efficiencies. Focusing solely on increasing sales is like
setting up a bunch of rain barrels next to your house and doing some frantic rain
dance in a loincloth while ignoring a massive water source right beneath your
feet.
Take Idaho, for example. Ninety-five percent of the state’s water supply comes
from underground. The 135 mile-long Big Lost River collects water from the
Rocky Mountains as it winds through Idaho and then just “disappears” as it goes
subterranean. The water from Big Lost River, Snake River and other
underground water sources collects in the Snake River Aquifer, which measures
400 miles wide. That is enough water to serve the majority of Idaho’s
agricultural needs. So that Idaho spud you’re munching on is thanks to an
underground water supply—not some rain dance Idahoans learned on the
Internet (albeit, Idahoans know how to get their funk on), or a band of merry
farmers capturing rain in buckets and turned-over cowboy hats.
Why should you care about Idaho and its underground lakes? Because 95% of
your company’s profitability is contingent on what goes on beneath the surface
(after the sales), not what happens in the sky (the sales themselves). And it is
what’s going on “underground” that will help you “find” gobs of money.
WHY EVEN FAT CATS NEED EFFICIENCY
Recently, I was asked to keynote the Global Student Entrepreneur Awards in
Washington, DC, where leading collegiate entrepreneurs from all over the world
gather and are recognized for their incredible impact. At breakfast on the
morning of the event, I ended up sitting next to Greg Crabtree. Greg is the author
of Simple Numbers, Straight Talk, Big Profits. Greg caught my attention
immediately, talking with another gentleman at our table about college football.
I inserted myself into their discussion (“Go Hokies!”), and soon enough the
conversation drifted from how this team is better than that one to entrepreneurs
and profitability. I remember thinking: “Hold on—we are talking about college
football and profitability. There is a God!”
After Greg recounted some information he shares in his book about how to
maximize profitability, I asked, “Is there such a thing as too much profit? Is
there a ceiling?”
“You always want to expand profit,” Greg replied. “In fact, you must, because
there are outside forces that will continually take your profitability away—your
competition. As you find ways to increase profitability, or even if you don’t,
your competition is doing the same. Everyone is trying to become more
profitable. And as businesses become more profitable, the competitive pressure
sets in and prices drop to attract more customers.
“When you figure out a big leap in profitability, the competition will sniff it out,
and it is just a matter of time before they do the same thing. Then someone drops
prices to get more clients, and everyone else, including you, has to do the same
to stay in business. This is how profits get squeezed.”
We’ve seen the phenomena Greg outlined over and over. Consider flat-panel
televisions, for example. They became commercially popular in the early 2000s
but were still a luxury item until around 2005, when the cost of big screen TVs
started dropping 25% each year. By the end of the decade, vendors had dropped
the prices so significantly that it seemed retailers were practically giving them
away. Then, because manufacturing televisions got easier and easier, profits
jumped, but only for a short time. It wasn’t long before everyone started
dropping prices again to capture demand, to the point where it now seems as
though a retailer needs to pay you to take a small or last year’s flat-panel model.
James Li, the chief executive of Syntax Groups—maker of the Olevia brand of
flat-panel televisions—said of his competitors, “If they go to $3000, I will go to
$2999.”
Another recent example of the profit squeeze phenomenon is the influx of
Internet marketers. In early 2000, a few guys figured out that you could make a
crappy information product, promote it with a grainy video made in your woodpaneled kitchen, email people with a “last chance to purchase” offer and make a
killing. The costs were next to nothing—a webcam, a couple PDF files, an email
marketing system and really, really bad lighting—and the returns were huge.
Profits approached nearly 100%, but only for a short time.
I suspect the early, “Wild West” years of information marketing were amazing
for those entrepreneurs, but within five years the landscape changed. Because
the industry was known for achieving high sales and record profits, the
competition came in strong. First there was the flood of GRiQs (Get-RichQuickers—the folks who pursue fast, easy money and give up just as quickly
when they find their scheme requires work). Supply quickly started to outstrip
demand, and consumers started requiring higher and higher quality. More
sophisticated marketers started making higher and higher quality stuff, which in
turn pushed prices down for everyone. That crappy, grainy video and PDF that
sold for $1997 (supposedly there is something magical about a seven at the end
of a number) in 2000 now sells for a $1.97 and comes with five years of one-onone coaching in the seller’s wood-paneled office. . . ahem, kitchen. Just as in the
flat-panel TV business or in any other business, it’s “hard” to become profitable
in information marketing. And that’s how it always goes.
Profit is a slippery animal. When profit margins are big, usually in excess of
20%, people sniff out and almost immediately start to duplicate what you’re
doing, and look for ways to do it better, faster, and above all, cheaper than your
company. I’m not, in any way, saying that you should stop investing in
efficiency and thereby (temporarily) increase profit. I’m saying that even if you
think you’re good with profit, you’re not. The competition will squeeze you
eventually, and soon, so keep finding ways to do what you do better, faster and
cheaper.
DO THIS FIRST
By now you’ve figured out that focusing solely on top line thinking (sales, sales,
sales!) does not lead to profitability. In fact more sales, without efficiency, lead
to further inefficiency. In other words, more sales make you less profitable. It’s a
vicious cycle. So before you can focus on sales, you must first nail Efficiency
101—and then take a few advanced classes.
Efficiency increases your profit margins, or, the amount of money you earn as
profit on each product or service you offer. It’s basic logic, easier than a
freshman math class—increased profit margins will boost your company’s
profits without the need for increased sales. And when you do kick the selling
machine into gear (which we will discuss in a few), profits will skyrocket. So the
method is simple—achieve greater efficiency first, then sell more, then improve
efficiencies even more and then sell even more. Over time, speed up the back
and forth between efficiency and selling until the two happen simultaneously.
Making your company more efficient is about more than just nixing extra coffee
breaks and redlining your expenses. To tap into the river of profit flowing just
under the surface of your company, you need to look at efficiency in every
aspect of your business. Serving the same types of (great) clients with the same
or very similar problems, using your one consistent solution to fix the problems,
is the route of efficiencies. You want to duplicate your best clients, because that
means they have a consistent need; and in turn, you want to reduce the variety of
things you do to the fewest that will best serve your best clients’ needs. Think
McDonald’s. That company is a moneymaking machine because they feed
hungry people—who don’t care, at least in the moment, about their health as
much as their hunger—with a few products: fries, hamburgers and breaded
chicken. The fewest things you can do repetitively to serve a consistent core
customer need—this spells efficiency.
I want you to set a massive goal for yourself. Look at every aspect of your
business and determine how to get two times the results with half the effort.
That’s a biggie, so I will say it again:
How do you get two times the results with half the effort?
Effort is financial cost and time cost (your time, your people’s time, your
software’s time, your machine’s time). For example, if you own a snowplowing
company and currently plow one parking lot per hour, I would ask you to figure
out how to plow two parking lots (two times the results) in thirty minutes (half
the time). Huge profits can had if you can pull this off—rivers flowing, my
friend. Rivers flowing.
Your first thought might be, “That’s impossible, Mike!” (You wouldn’t believe
how often I hear this. Wait. Maybe you would.) If you believe that it’s
impossible to increase efficiency in this way, you are trapped in “let the other
guy figure it out” mode. If instead you say, “Hmm. . . let me think about that.
Let me find a way,” you will skyrocket to profitability. Why? Because
innovation occurs in small steps, big leaps and everywhere in between. To
double the results with half the effort is a big goal that forces big thinking, and it
brings about small and big progress—all of which goes to the bottom line.
The biggest innovators ask big questions. Do you think Elon Musk asked, “How
do I get a few extra miles per gallon?” when he thought up Tesla? Or, “How can
people transfer money a little bit faster than a bank wire?” when he started
PayPal? As he worked on his Hyperloop supersonic speed-train concept—the
one that travels through a complete vacuum system running from LA to San
Francisco—do you think he was considering how to be a little bit faster than the
Greyhound bus? Hell, no! Innovation in business and innovation in efficiencies
comes from big, bold questions.
Most entrepreneurs focus only on tiny improvements—“How do I do this a
couple of minutes faster?” Small questions yield small answers. Plowing a
parking lot five minutes faster is not going to make much of an impact on your
bottom line. Just skip the coffee break, or just “hold it” when you need to go to
the bathroom.
But the more you focus on substantially improving efficiency (like with a design
for a plow that can move snow twice as fast), the closer you’ll get to achieving
double the results with half the effort. This gain in efficiency is amplified the
more you sell. That is the power of percentages. Since you now plow every
parking lot more efficiently, every new account is an opportunity for increased
profit.
Did you know that United Parcel Service (UPS) trucks almost always take right
turns? In 2006, UPS dared to ask the efficiency question about fuel costs. They
discovered that the less time UPS drivers spent in left turn lanes, the less fuel
they burned waiting at lights and to cross traffic, and the less idle time there was
for each driver. UPS is now experiencing a savings of $6,000,000 a year from
the change.
The “brown truck” company didn’t stop with their first efficiency discovery.
Next time you see a driver delivering a package, look at him and try to spot his
keys. Let me give you a hint: They are not in his pocket (that’s a banana). UPS
drivers found that fumbling for their keys in their pockets when they got back
into the truck cost them five to ten seconds (or more) every time. UPS figured
out that it is more efficient to keep their keys hanging from their pinky fingers.
Now, a UPS driver makes a quick flip of his wrist and the keys are in his hand.
Multiply that saved five to ten seconds by fifty stops a day and five gazillion
drivers and you have a very huge savings indeed.
UPS also found that they could save millions by washing their trucks once every
two days rather than every day. Over time, this gave them huge savings in time,
energy and water—and the trucks looked just as shiny.
Look, it may seem impossible when you first hear my challenge, but if you’ve
never asked yourself, “How can I get two times the results with half the effort?”
how will you know if you can? You might be missing your own no-left-turn,
pinky-flip, don’t-wash-yourself efficiency miracle and not even realize it.
FIRE BAD CLIENTS
If you read my book The Pumpkin Plan, you know that, while the book is
outwardly marketed as a system to help business leaders grow their companies
into industry giants, it’s secretly a book about efficiency. Letting go of clients
who suck us dry and eat up our profit margins is a way of making space for
clients we can serve exceptionally well by doing what we do best and with fewer
resources. It is all about improving not only the top line, but the bottom line, too.
A study facilitated by Chicago-based growth-consulting firm Strategex analyzed
the revenue, cost and profit breakdown for a thousand companies. What they
found was nothing short of a “duh” moment, as in the “Duh, I already knew this
but I still haven’t done anything about it in my own business because I’m a
glutton for punishment”-type duh.
Strategex sorted the clients for each company into four sections, in descending
order based on revenue. For example, if a company had a hundred clients, the
twenty-five clients that generated the most revenue were put in the top quartile,
the next twenty-five highest revenue-generating clients in the second quartile,
and so on. Strategex found that the top quartile generated 89% of the total
revenue, while the lowest quartile only accounted for a meager 1% of total
revenue.
Wait. It gets worse. The study found that each group of clients required pretty
much the same amount of effort (cost and time). This means that it took the same
amount of effort to serve a big-revenue client as it did a client who barely
affected revenue at all.
Then came the awkward “gulp” moment. Strategex’s profit analysis showed that
the top quartile generated 150% of a company’s profit. The two middle quartiles
were effectively break-even, and the bottom quartile, the one that generated 1%
of the total revenue, resulted in a profit loss of 50%! In the end, the profits
generated from the top clients are used, in part, to pay for the losses accrued in
serving the bottom clients.
I’m sure you know this scenario all too well. Those clients who barely pay you
peanuts, yet constantly complain about how much you charge and how you do
nothing right; the clients who demand you rework everything you’ve done for
the third time and then never pay you for your work, or never pay you on time—
those clients are costing you money. Get rid of them. Fast!
Dumping your worst clients may seem counterintuitive at first. But never forget
what I said earlier: All revenue is not the same. If you remove your worst,
unprofitable clients and the now-unnecessary costs associated with them, you
will see a jump in profitability and a reduction in stress, often within a few
weeks. Equally important, you will have more time to pursue and clone your
best clients. I’ve lost count of how many readers have shared their stories of how
both their top line and bottom line improved after they implemented the growth
strategies I revealed in The Pumpkin Plan. I know that sounds like bragging, but
it’s not. The system isn’t some miracle that I came up with; it is just simple
math.
I know how scary it feels to dump any client when you are scrambling to cover
this week’s payroll, especially if you fought hard to get that client in the first
place. But remember, profit is about the percentages, not a single number. So
take it easy on yourself. Start by dumping one rotten little pumpkin in your
patch, the one you occasionally fantasize about leaving on a deserted island or
shipping off to Mars. The emotional distraction that client caused you and your
staff will disappear immediately. The profits you earned from other clients and
were spending to keep this bad client on board will now stay in your pocket. And
since his special requirements no longer need to be serviced, you have time and
headspace to find another, better client—an ideal client, a clone of your very
best clients.
CLONE YOUR BEST CLIENTS
Just for a moment, I want you to think of your favorite client: the call you will
always take, the person or company you say yes to without hesitation. This is the
client who pays you what you’re worth, on time, without question. This is the
client who trusts you, respects you, and follows instructions. This is the client
you love, and they love you. Now imagine if this client had five identical twin
companies that all wanted to work with you. Wouldn’t that boost your business?
Wouldn’t it be easy to serve those clients? Wouldn’t it help you keep your
bottom line healthy? Now imagine ten clones, or a hundred clones.
For almost any B2B business in the world, landing a hundred clones of their best
client would put them at the front of the pack. They would dominate. The same
is true for B2C businesses. If just a mere 10% of their clients behaved like their
number one client, those businesses would rule, too.
Having clients with similar needs and very similar behaviors offers a few
magical profit-making benefits:
1. You will become super-efficient, because you now serve very few
but consistent needs, rather than an excessive array of varying needs.
2. You will love working with your clones, which means you will
naturally and automatically provide better service. We cater to the
people we care about.
3. Marketing will become automatic. Birds of a feather flock together
(for real) and that means your best clients hang out with other business
leaders who have the “best client” qualities you’re looking for. Your
best clients are awesome, remember? You love them and they love
you, and that means they will talk you up every chance they get.
Clones of your best clients are the very definition of efficiency, which is why
they are like gold. Find them. Nurture them. And then find out where even more
best-client clones hang out and cultivate them, too.
SELL SMART
I mentioned Ernie briefly already, but I want you to know a little more about his
story. It speaks to how fast things can go down the “upselling” rabbit hole. In the
fall, I pay my lawn service to come clean up all of the leaves in our yard. This
past year, Ernie, the owner of the business, knocked on my door. He had just
finished the leaf clean-up and said, “I noticed that there are leaves in the
gutters.” He offered to remove them, for a fee. And I, my friends, was what they
called a “captive customer” and an “easy upsell.”
I said, “Yes, do it,” without any hesitation.
Ernie had just expanded his service offering. Easy money. Yippee. To complete
the job, Ernie had to run out and buy some ladders for his truck. He came back
thirty minutes later and got right to work. Because he pulled out the leaves by
hand, he wasn’t super efficient, but he got it done fast enough. However, he
didn’t have the tool to snake out the downspouts, so he made a note to buy it and
come back at a later date to finish the job.
While Ernie was up on the roof, he spotted another opportunity— fixing
damaged shingles. More easy money! More revenue! Again he asked me, I said
yes and he ran out and picked up some roofing tools (and a downspout snake
tool thingy). He came back an hour later, replaced the shingles, cleaned the
downspouts—and, while doing that work, noticed a crack in the chimney and a
soft spot on the roof, a sign of rotting wood. When Ernie approached me about
it, I asked him to fix those things, too. This time he went out to get more tools,
band saws, cement, brick supplies and temporary labor. Ernie came back near
the end of the day and pushed through to get it finished. He even bought
floodlights to keep the work area lit as dusk approached.
At the end of the day, I paid $1500 for all the work. Not a bad deal, considering
Ernie “only” gets paid $200 to clean the lawn. But… the $1500 he earned cost
Ernie an investment of about $2000 for tools and supplies that day, plus a lot of
driving back and forth and the cost of hiring a laborer.
Ernie lost money on me, but he grew his sales by a lot. Tomorrow he intends to
use his new equipment and tools to take care of other clients and will, in theory,
earn his money back and then some. The problem is, that rarely happens. As the
bills mount, the pressure grows to sell more and more; and you end up working
on projects in which you have limited experience and sometimes little interest.
As the variety of things you do increases, you need to buy more tools and
equipment and hire more specialized labor. And none of this gets used to its
maximum potential, because you do many different things, not one thing. Your
stuff sits there unused. While you rake lawns, your ladders just lie there. As you
fix roofs, the leaf blowers just sit in your truck.
You get stuck in the Survival Trap and end up not doing a very good job at any
one thing. For example, when Ernie wrapped up for the day he said, “I’ll be back
early tomorrow to clean the lawn again.” Why? Because he threw the leaves
from the gutters onto the lawn he had just cleaned, as well as shingles and other
things. His additional work required that he actually redo his original work,
while all that new gear he bought just sat on his truck, not being used. What’s
efficient about that? Nada.
Across the street, my neighbors Bill and Liza hire a different guy, Shawn, to
clean up their leaves in the fall. He also charges $200. On the same day Ernie
worked on my house and earned $1500, Shawn serviced four more properties
and also knocked on the doors at two other properties that, by the look of their
lawns, needed his help.
I suspect that if Ernie and Shawn had had a beer together that night, Ernie would
have boasted about doing one-and-a-half times the sales Shawn pulled, but
Shawn would have ended up paying for the drinks. Shawn has achieved
efficiency, and recognizes it as the magical sauce of profitability—getting more
of the same things done with better and better results, using fewer and fewer
resources.
Selling more is the most difficult way to increase profits, because in the bestcase scenarios, the percentages stay the same; and in the worst-case, more
common scenarios, expenses generated to support sales increase faster, resulting
in smaller percentages and a smaller profit margin.
•••
A man went in search of the perfect picture frame at a flea market in
Adamstown, Pennsylvania in 1989. He found it holding a torn painting of a
country scene. When he got home and dismantled the frame, he determined that
it was not salvageable. But something else was.
Folded and hidden in the backing was the Declaration of Independence. Five
hundred official copies had been used to spread the news of America’s
independence to everyone in the twelve colonies, and John Dunlap had printed
this specific copy on July 4th, 1776. The man who found it took actions both to
sell it and to remain unidentified. I’m not surprised—that $4 frame purchase
turned over to 2.4 million dollars two years later, when it was sold by Sotheby’s
to a private investor.
The guy looking for the frame is a success by any measure, right? He found the
money under the surface. But if you think of him as a success, you’re wrong.
Sure, stumbling across success is cool, but making a process for finding profits
under the surface is the real success.
This guy figured out that there is potentially big money hidden in frames. But if
he only hopes to find another historical document one day, he is hoping for it to
rain, not pursuing efficiency by identifying regions where such documents
originated and searching flea markets only in those areas, focusing on frames
made during a specific time period and buying inspection tools to look through
the frames to see if there is anything inside. Can you imagine combing the flea
markets without these and other efficiencies in place? He’d go broke trying to
find that elusive rare document, trying to make it rain.
Sales without first putting efficiency measures and systems in place is a
dangerous game that only leads to bigger expenses and fewer ideal clients.
Applying efficiency strategies to your top line—firing bad clients, cloning the
good ones, refining your offering to get the most out of your resources and then
selling smart—is a surefire way to increase profitability.
ACTION STEPS
LET GO OF DEAD WEIGHT
Step One: Focusing on one aspect of your business (one that benefits your best
customers), challenge yourself to figure out how to get two times the results for
half the effort. Just pick one component and figure it out. Set a goal of
accomplishing this task for a different aspect of your business every week, until
you’ve looked at the full scope of your company and found ways to ensure you
are running it with maximum efficiency. Shoot for the stars and you just might
hit the moon.
Step Two: Using the parameters outlined in this chapter, identify your weakest
clients. Fire the weakest links. I’m not suggesting that you get into ‘Take This
Job and Shove It” mode. Don’t burn any bridges. Just politely end the
relationships. You’re not dating anymore, but you can still be friends.
CHAPTER EIGHT: Sticking With It
As I write this, we’re having a mother of a bad winter here on the East Coast. I
hear other parts of the country also have it rough, but I’ve been snowbound in
my house for what seems like eighty-four years, afraid to turn on the Weather
Channel in case I might finally, permanently lose my mind. I’m not sure which
state has had the worst of it, but while my heart feels it is Jersey, I’m pretty sure
it’s Minnesota. Actually, I’m convinced it’s Minnesota.
The other day I caught up with Anjanette Harper, one of my best pals and the
best damn writer on this planet, who lives across the border in New York. We
were trading war stories over the phone about how the latest storm had affected
each of our towns when she said, “Mike, I survived a mile-long hike in the
Minnesota Northwoods… in January. We were sent out in waist-deep snow with
nothing but a compass, some matches and a bag of granola. This winter has
nothing on me.”
Anjanette went on to tell me a hilarious story about Camp Widjiwagan (yes,
that’s its real name), a winter camp she attended with her classmates near Ely,
Minnesota when she was thirteen.
“It was ridiculous—we were this group of private school kids from the city sent
to an environmental camp way up north during the coldest month of the year.
We weren’t allowed to use the one indoor bathroom except to brush our teeth—
seriously, the toilet seat had duct tape over it—instead, we had to put on three
layers of clothes plus outerwear to trek out to the biffies (outhouses) in the
woods to pee. I could barely walk in all of those layers, and it seemed like the
biffies were miles away. I’m surprised my eyeballs didn’t get frostbite. Just try
going to the bathroom in the middle of a pitch-black night on a frozen toilet seat
in a tiny wooden shack, with two active wolf packs howling at each other
nearby.”
I laughed so hard as Anjanette went on to tell me about a blind hike on a frozen
lake (soundtrack: wolves!), building a quinzhee (an igloo), and putting up with
earnest environmentalists who had no sympathy for the plight of pubescent
teenagers not permitted to wash their hair. But it wasn’t until she explained how
the counselors managed to get the campers to change their wasteful habits that I
realized I had to share her story with you.
“The first night, after we had dinner, we were asked to scrape the leftover food
on our plates into a bucket. I assumed it was because they wanted to feed our
scraps to some special breed of pig that could survive in the tundra, but then I
saw the scale. One of the counselors weighed our combined leftovers and
announced that we had managed to waste several pounds of food.
“Being a bunch of privileged brats, we responded with, ‘Yeah, so?’ “And then
we were lectured about how a few pounds of waste, repeated daily, adds up to a
few tons of waste, and soon enough that adds up to a few landfills full of waste.
Next, we got the ultimatum: We had to get the waste-per-meal down to a few
ounces by the end of the week. I can’t remember what the exact consequence
was if we didn’t pull it off, but it was something outrageous, like forcing us to
square dance. . . with each other.”
Anjanette went on to explain how, in the days that followed, she and her
classmates held each other accountable for the amount of food they left on their
plates at the end of each meal. They strategized and came up with solutions—the
most important of these was to take smaller portions to begin with.
“We helped each other out,” Anjanette explained. “If, after I was done eating, I
still had vegan mashed potatoes on my plate and Ted and Brian wanted second
helpings, I would pass them my leftovers. We nudged each other (or shouted at
each other, take your pick) when our plates were piled too high with food.
Toward the end, when it looked like we might not reach our goal, we really put
the pressure on each other. Because, let’s face it—we’d just hit puberty. We
would have done anything to avoid having to touch each other, much less partner
up for a square dance.”
By the last dinner, Anjanette and her fellow campers surprised even themselves
—they got that bucket down to zero waste. Zero. Zilch. Squat. As in, no one
needs to do anything with the two words that should never be said together. . .
square and dance.
When I asked Anjanette if any of the eco-friendly lessons she learned at Camp
Widjiwagan stayed with her, she said, “I still turn off the water when I brush my
teeth. And I’m more likely to shop for a few days’ worth of groceries rather than
stock up, because I despise throwing out food. So yeah, it stuck. I mean, I never
want to see a snowshoe again, and the only school event for my son that I ever
intentionally missed was the square dance; but it did change the way I think
about using our natural resources.”
In essence, what Anjanette and her friends did was form an accountability group
to ensure they met their goal. I’m a huge fan of accountability groups because
the benefits are numerous. Chief among them:
1. When you go through a painful process with others, the pain is
diminished.
2. The action of enforcing a plan or system with someone else ensures
that you are more likely to do your part. You are accountable to the
group, and therefore integral to the group, which means you are less
likely to drop the ball.
3. When you meet regularly with an accountability group, you get into
a rhythm that makes it easier to stay the course and achieve your goal.
Big aspirational goals get broken down into smaller achievable
milestones.
The worst enemy of Profit First is not the economy, or your staff, or your
customers, or your mother-in-law. Well, maybe it is your mother-in-law. . . but I
digress. The worst enemy of Profit First is you. The system is simple, but you
have to have the discipline to implement it consistently. If you do this, your
company will be profitable, no question about it. The problem is, we are own
worst enemies. We won’t do the Debt Freeze all the way (or at all). We won’t
cut back on our staffing expenses or move into a grade -D office space. And we
will steal from ourselves, taking money we allocate for profit to pay bills. We
will steal from our Tax Accounts to pay our own salaries. We’ll borrow. We’ll
beg. We’ll steal (from ourselves). And we will find a way to justify it all, at least
to ourselves. This is why it is imperative that we join (or start) an accountability
group… immediately. Otherwise, there will be hefty consequences to our actions
. . . and I guarantee they won’t be as easy to face as forced square dancing.
ACCOUNTABILITY GROUPS WORK
Thomas Edison said, “Genius is 1% inspiration and 99% perspiration.” I’m sure
he would agree that success with Profit First is also 1% inspiration and 99%
perspiration. It is in doing that things get done, and in sticktoitenacity (yes, I
made up a word) that results are achieved.
And I’m convinced Jean Nidetch would agree with good ol’ Edison. Nidetch
founded Weight Watchers in the 1960s, not with the intention of creating a
wildly successful business, but with the goal of fixing a problem. (Isn’t that how
most great companies begin?) Throughout her childhood, Nidetch struggled with
her weight. The problem continued and, by age thirty-nine, she weighed 214
pounds. Nidetch sure as heck didn’t wear her weight like bikini model Amazon
Eve, either.
After a run-in with a neighbor at the supermarket, Nidetch was finally motivated
to lose weight. As the story goes, her neighbor complimented her on her
appearance and then asked, “How exciting! When are you due?”
Not pregnant, Nidetch decided enough was enough. She started a diet
recommended by a nutritionist and lost 20 pounds. Then, like so many of us, she
lost her resolve.
Realizing she needed help, Nidetch reached out to several of her friends who
were also trying to lose weight and founded a weekly support group. With the
help of the group she lost another 52 pounds. All her friends lost weight too.
That group eventually became Weight Watchers.
Nidetch celebrated her ninetieth birthday in 2013, having enjoyed more than
fifty years of good health thanks to a sound nutritional system for losing weight
and an accountability group to help ensure that she met her goals and never
gained the weight back.
The science behind losing weight is simple: Consistently eat fewer calories than
your body burns. Just as with Profit First, however, if your resolve falters, the
system falls apart. This is why everyone— including me, including you—needs
an accountability group. I don’t care how disciplined you are, at times your
willpower will fade. You need other people who are working the same system to
help you stick to it during your toughest times, and will help you to help others
do the same.
Weight Watchers meetings are facilitated by trained leaders using an established
curriculum. These leaders have lost weight following the Weight Watchers
system. They don’t just teach it, they live it.
The fact that accountability groups work is nothing new. In fact, churches use
them to help keep members focused on their faith. In The Power of Habit by
Charles Duhigg, he explains how Rick Warren, a Baptist pastor, created his
congregation. When Warren realized that his weekly motivational sermons were
not enough to keep people focused on the lesson during the week and better able
to meet challenges, he implemented small Bible study groups. His sermons were
reminders of the lessons of their faith (a system of its own) and the small groups
helped his congregation to stay focused on the lessons and implement them in
daily life. Soon, 95% of Warren’s church activity was happening during the
week, in the small accountability groups.
Incidentally, Thomas Edison was part of accountability/ mastermind group with
Henry Ford, Harvey Firestone and John Burroughs. They called themselves “The
Four Vagabonds,” and though the group began as a camping tour, it was really
much more. Together they mastered entrepreneurial domination and the everelusive secret trick to making a perfectly toasted marshmallow.
Knowing Profit First is only 5% of the game. To win it, you need the other 95%
—and you’ll get that in your accountability group.
GET STARTED
By now you know my philosophy on getting started—why wait? Do it now! To
make it easier for you to get involved in your own accountability group, I’ve
outlined the types of groups you could join, or start.
PROFIT ACCELERATOR GROUPS
Profit Accelerator Groups (PAGs) are facilitated by Profit First Professionals
(PFPs), financial professionals or business coaches who are trained in the Profit
First system, use it in their own businesses and help other entrepreneurs and
leaders to implement it in their own companies. PAGs meet monthly or
quarterly, face-to-face, at a Profit Center, at your (or another member’s) facility
or at their own dedicated facility. Some meetings take place over online
videoconferencing.
PFPs have established, proven track records in fiscal/business management; they
are accountants, bookkeepers, business coaches, business attorneys, financial
planners and bankers. They also have access to the latest Profit First resources
and know how to use them. PFPs enforce accountability and profitability;
facilitate the sharing of best practices; and direct members on debt reduction,
cost reduction and building efficiencies.
Why is working with a PFP an advantage? It’s like working out with a
professional trainer—you’re going to get where you’re going faster and more
safely and efficiently. PFPs can guide you through the nuances of applying
Profit First to your business, drawing on their expertise in working with many
types of businesses and sets of special circumstances. PFPs have gone through
this process many, many times, and that cumulative experience means they have
already seen all the roadblocks you will face and are well-equipped to help you
get around them.
If you would prefer to work with a PFP outside of an accountability group, most
of them work one-on-one as well. PFPs do charge for their time, but man-ohman is it ever worth it. Debra Courtright, the bookkeeper I mentioned in Chapter
1, is a PFP. She runs accountability meetings in her office; I was a member of
one of the groups and met in her office for more than a year. No surprise, the
entrepreneurs in her groups get to their financial objectives faster than most
business leaders I’ve met.
Accountability works. Having a professional give you good shortcuts specific to
your business works even better—it accelerates your profitability.
Michael Agulario of Gold Medal Services runs a $25,000,000 company and is in
a PAG facilitated by his PFP, an accountant. One of the added benefits
Michael’s PFP brings to the group is, he offers to be the “bad cop” in vendor
negotiations. Michael brings his PFP along to every meeting with vendors who
are expensive but necessary to an efficient, profitable business. Then, Michael
plays “good cop” while his PFP plays “bad cop” in order to get the best deal—
sometimes saving hundreds of thousands in the process.
For example, after a pitch from his Yellow Pages sales rep, Michael said,
“Sounds great. I want it.”
But his PFP went all “bad cop” and said, “Michael, this is ridiculous. You can’t
afford this, or justify it. I want you to cancel the service.”
Because Michael conceded to his PFP, the sales rep offered a lower price—
slicing his Yellow Pages bill by $500,000! And he got double the run time for
his ads. This negotiation is no different from any other, but Michael stays the
“good cop” and can remain on friendly terms with his vendor.
For a list of PFPs, including those who run PAGs in your area, visit
MikeMichalowicz.com/Resources.
PROFIT PODS
An alternative to joining a PAG run by a PFP is to join or start a voluntary Profit
Pod. These groups are led by Profit Leaders, entrepreneurs who decided to start
a Profit Pod as a way to help themselves remain accountable and help their
colleagues do the same. While Profit Leaders do not run financial businesses, are
not business coaches and have not been trained in Profit First best practices, they
do have a passion for profitability.
The format for Profit Pod meetings is open source, but there are rules. Profit
Leaders may not charge for the meetings except to cover any outright,
documented costs (such as Meetup.com fees, room rental or food), and they may
not solicit your business (nor may any of the members solicit business from
other participants).
Because Profit Pods are open source, they are one hundred percent independent.
To find one in your area, search the web, check out Meetup.com, BigtTent.com,
Mightybell Circles or Facebook groups, or ask in entrepreneurs’ forums. Group
members enforce the Profit Pod rules, so if you’re not happy with how a
particular group is being run, give them an honest critique and leave the group.
Then join a new Profit Pod, or better yet, start your own and run it the right way.
PROFIT LEADERS
Becoming a Profit Leader and starting your own group can be a fantastic way to
ensure you not only are accountable to the Profit First system, but also are
gaining the most from knowledge and experience as you tweak it to suit your
company’s needs.
At a recent speaking engagement on a local college campus, I asked my friend
JB Blanchard to join me. JB had implemented Profit First in his roof-decking
company, RoofDeck Solutions, Ltd., and wanted to share his experience with the
students and professors in attendance. As we hustled over to the event, we
passed a classroom.
JB pointed into the room and mumbled, “There he is. There’s the best student.”
Because I was mentally rehearsing my speech, I didn’t ask him what he meant
by that.
We walked by another classroom and he blurted, “There’s the best student,”
pointing into the very full room.
That got my attention.
As I turned to ask him his criteria for identifying the best student, JB pointed
into another classroom and said, “Over there, that woman. She is the best student
in the room.”
I stopped walking and looked at JB. “What are you talking about? How can you
pick out the best students so quickly?”
“Easy,” he said. “The best student is always the teacher.”
Ahh, yes. This is why we teach—to learn, and to master. This is, in part, why
Weight Watchers has such an amazing track record helping people lose weight
and keep it off. Jean Nidetch, the founder, doesn’t run the meetings or conduct
teleconference after teleconference. No, her best members are the facilitators—
her best students are the teachers.
Profit First is no different. If you want to master Profit First for your business,
you need to teach it. Become a Profit Leader.
To make it easy for you to start your own Profit Pod, I’ve created a structure for
you to follow (see below) and a Profit Pod Starter Kit, which includes
instructions and core guidelines for how the meetings are run. You can
download your own free copy at MikeMichalowicz. com/Resources.
STARTING A PROFIT POD—JUST TWO
The fastest Profit Pod to start only has two members—you and one other
entrepreneur. The meetings are easy to manage and are over quickly. However,
with a group this small you will not have the input of a financial expert or the
power of input from a group of people. (Note: You cannot do this with a
business partner or anyone who has a vested interest in your business.)
Everyone knows that you’re more apt to show up to the gym if you have a
workout partner there waiting for you. You might even work harder because you
are there with your partner. But don’t pick just anybody—your Profit First
buddy has to want profitability as badly as you do. They have to “get it.”
Without shared values, passion and determination, meeting up with your Profit
First mate would be a bit like meeting your workout partner at Dunkin’ Donuts.
So pick someone who wants a healthy, profitable business just as much as you
do. Better yet, find someone who wants it more.
When you partner up, become champions for each other. Yet be aware that,
when there are only two of you, it is easier to get away with little white lies. We
say, “Yes, I put the money into the account,” when really we only intended to
put it in, but never followed through.
The goal of accountability is to be integral to your Profit First system, not to
punish each other for doing (or not doing) certain things. Instead, look for ways
to improve discipline and cheer each other on for following the system. For
example, you may decide that, rather than tell each other you made the deposit,
you will email screenshots of your bank accounts to each other before your
meeting or, if you’re meeting in person, bring a print-out.
A Profit Pod of just two should meet on the phone, Skype or face-to-face twice a
month. It’s best to meet on the 11th and 26th (or whatever convenient day comes
soon after you do your 10/25 Rhythm). When you meet, share your profit status;
discuss any problems; share tips and tricks you have found for improving
profitability and sticking with it; and hold yourselves accountable to tasks that
will drive profitability.
Here’s how to form a Profit Pod with just two members:
1. What you want in a partner is someone you already know but are
not friends with. Inviting friends to join your group can lead to some
messy stuff. I get it—you know your friends. You go way back. You
want them to succeed. But trust me when I say that including your
friends in your Pod is not the way to maximize the experience. You
need honest communication between members who have no reason to
be jealous or hurt, or to gossip to mutual friends about what they might
have heard you share in the meeting. So choose a business
acquaintance, someone you know delivers on commitments (that way
you will be less likely to break yours).
2. If you prefer to work with someone you don’t know, look online.
Search Google for “Entrepreneur Online Forum” for a list of forums,
and when you find one that is particularly active, post an inquiry in the
forum for an accountability partner. Be very specific about what you
want to do (e.g., have a call every two weeks, support each other in
profitability, etc.). One of my personal favorites is The Fastlane
Forum, managed by entrepreneur and business author MJ DeMarco.
Interview prospects the same way you would a potential hire, asking
whatever questions you feel are necessary to ensure confidence in this
person. Be smart. Get references.
3. Another option is to post a tweet or Facebook status update: “I am
looking for an accountability partner to focus on business profits.”
You will find some amazing people, and by using this method you will
be able to weed out people who are interested but not committed.
When I posted this same message on Twitter, two people responded
with interest within a few minutes. I deliberately did not respond—
after all, a good accountability partner is persistent. You know what? I
never heard from those two people again. And just like that, they were
off my list of potential partners.
Here is the core structure for running a Profit Pod with two people:
1. Schedule biweekly meetings around the 11th and 26th to correspond
with your 10/25 Rhythm. A key factor in maintaining a successful Pod
is to schedule your meetings a full year out, and then schedule your
life around them. If you wait until you are both available to meet, you
won’t meet often enough for the group to work its magic.
2. Even with just two members, choose who will lead the agenda. The
agenda for a fifteen-minute meeting is as follows:
a. Instant Profit First CheckIn: In turn, each partner asks, “How
healthy is your business?” and the other partner replies with a onesentence assessment.
b. Three-Minute Update: Partner One gives a three-minute update
about her business, including the thing(s) they agreed to be
accountable about from the prior call, with no discussion.
c. Profit First Report: Partner One gives an update on current balances
in her Profit Account, Tax Account and, if you have agreed to share
the information, the Owner’s Pay Account. Also, Partner One reports
how much money was allocated to each account since the last meeting.
This is the ideal time to email a screen shot of the relevant balances, to
avoid cheating yourself.
d. Challenges Report: Partner One shares any struggles she may be
having in allocating funds, and any potential problems or roadblocks
that may be coming down the pike. If there are no challenges to report,
simply say so.
e. Wins! Report: Partner One shares new “wins” and findings that may
have happened in her business since the last meeting (e.g., ways to
increase profits, methods for better adherence to Profit First, new
sales, new processes, increased Profit First percentage, etc.).
f. Discussion: To get clarity, Partner Two asks Partner One up to three
questions about her challenges and then asks for commitments to
solutions. Partner Two then asks up to three questions about Partner
One’s wins, and for commitments to how she will repeat and grow
them. The goal here is not to give advice or fix each other’s problems;
it is simply to put accountability in place.
g. Now, flip.
h. In turn, Partner One and Two each close with a commitment of up
to three actions to further serve the health of their companies. Confirm
the next call and get to work.
3. Every quarter, when you take a distribution, acknowledge your
partner. Share how you plan to celebrate with your profits, no matter
the amount. Give each other a virtual high five. Discuss ways to
improve your accountability. The outline above can get boring quickly
if you simply repeat it at every meeting, so think about ways you
might freshen up the process. For example, you might start reading a
book together. (Cough. The Pumpkin Plan. Cough.) When you have
your call every two weeks, discuss another chapter from the book and
how you will (or won’t) implement the ideas.
STARTING A PROFIT POD/PROFIT ACCELERATOR GROUP—THREE
TO TEN
A group of two members is easy to form, but if one person misses a meeting or
starts to slack, the group is done. And, with only two members you are limited to
input from. . . well, just the two of you. There is power in numbers. With three to
ten members you have input from several people, and you have a chance to
rotate Profit Leaders. Phil Tirone, my friend the former mortgage lender and
founder of 720CreditScore.com, founded my accountability group. There are ten
of us in the group, and though Phil got us started, he doesn’t lead alone. We
rotate leadership responsibilities every quarter, and this process has truly
elevated the group. It also breaks us out of doing the same thing all the time.
These groups have the feel of advisory boards.
Starting a Profit Pod or PAG of three to ten members can be a bit like herding
cats. And if your group starts networking and conducting business together,
things can go sour. So be sure to clearly state the rules of the group and make
sure that everyone abides by them. Many PFPs facilitate groups of this size, so
consider joining one of these professionally-run groups and getting their
direction on running your own Pod.
You can use the same tools for finding your members detailed in the section
above. Also, if you are in an existing group, consider plugging Profit First
accountability into your existing core structure. For example, I have been a
member of Entrepreneurs’ Organization and in a forum (a blend of a mastermind
and an accountability group, typically six to ten men and women) for fifteen
years. We added Profit First to our group’s agenda—a simple fifteen-minute
plug-in—and it’s been working well for everyone.
As is true of groups with only two members, the goal of the group is to work
with other entrepreneurs and business owners who are committed to building
profitable organizations, supporting each other in the process and holding each
other accountable.
Here is the core structure for how to run a Pod or PAG with three to ten people:
1. After participating in accountability groups and masterminds of all
sizes I have found that, for what we need to achieve, the best format is
quarterly face-to-face meetings and biweekly rapid-fire checkins (see
core structure above for the rapid-fire checkin agenda). The biweekly
checkin (45 minutes long) is necessary because business changes
constantly. All of our wonderful plans go out the window when a
client suddenly goes bye-bye, and we need the biweekly checkin to
make adjustments and deal with challenges. The quarterly meetings
allow for a deep dive to support each other at a much more tactical
level.
2. First Meeting: When a new group forms or a new member joins an
existing group, it is critical to establish a strong, deep connection
immediately. Now, before you say this can’t be done, try getting stuck
in an elevator with someone you don’t know for an hour—you will
become best of buddies for life. It can be done; it just needs to be
structured correctly. Allow an hour and a half for a first meeting if you
are meeting often, and if you are doing a deep-dive group, allow four
hours.
3. Master Exercise: I will never forget my first deep-dive
accountability meeting back in 2011. Our group decided we would
start with an exercise called “Full Financial Disclosure.” I call it
“Getting Naked.” We agreed to walk into the meeting with our tax
returns, bank statements, loan statements, credit card statements—all
that stuff we normally wouldn’t want a business colleague to see. Talk
about a bonding exercise!
4. No Business: You may not do business with each other. You can
refer work, you can help each other, and you can give freebies if you
must (I suggest avoiding that), but no matter what, no money changes
hands. Not only do things go sour if there is a problem (and it will
affect the whole group), but complete honesty also goes away because
your vendor or client is now in the room.
On my website, I share detailed examples of agendas for first meetings, checkins
and
deep-dive
meetings.
To
download
the
agendas,
visit
MikeMichalowicz.com/Resources.
PROFIT CENTERS
After I started centering some of my speeches on Profit First, large businesses
approached me. They wanted in. From my early conversations with these
businesses, an idea was spawned for Profit Centers: locations in which small and
large businesses provide free space for face-to-face PAG and Profit Pod
meetings. Many banks, for example, have conference rooms (and lollipops).
Some corporations have auditoriums (and lunchrooms). What better way to have
a meeting than at one of the bank branches? After you wrap up the meeting, you
can each walk up to the teller and make your Profit First deposit, or your
quarterly withdrawal for your Profit First celebration!
Then other corporations approached me, wanting to offer discounts on their
products and services. They realize that a Profit Pod represents great clients for
them (hey, big business needs to be profitable too), and that it is effectively a
small buying club.
For a current list of Profit Centers, visit MikeMichalowicz.com/Resources. If
you don’t see a conference meeting space in your area (or services and products
that you want at a lower cost point), simply contact me and we will work to get
one listed.
KEEP THE GROUPS HONEST!
In Dan Ariely’s book The (Honest) Truth About Dishonesty, he explains how we
lie to everyone, including—or, says Ariely, especially— ourselves. In short, he
explains how, if given the opportunity, most people will cheat a little. Few
people are big cheaters—the kind you see on America’s Most Wanted—but
everyone is a small cheater. We call our cheats “little white lies” to soften the
truth and make ourselves feel better about cheating, but it’s still cheating.
Weight Watchers meetings kick off with a weigh-in. You step on the scale and
the facilitator notes your weight; you are the only two people who see it. There is
no public embarrassment, but also no opportunity to lie. Ultimately, you come
out winning because you can’t lie to yourself.
You can’t lie with Profit First, either—not to your peers and not to yourself. This
is how we make sure small cheats and little white lies don’t happen in a PAG:
Each member must bring the printed-out statement from his Profit Account to
each meeting. (Or, if you are meeting online, send a screenshot via email.)
Numbers do not lie, even if we are tempted to do just that. (Just a teensieweensie bit.)
Just as it works with Weight Watchers, you don’t need to show your number to
the entire group. You just need to share it with your PFP if you’re in a
professionally facilitated PAG. If you are in a volunteer Profit Pod, your group
needs to designate one person to be the number validator. By sharing this
indisputable evidence with one person other than yourself, you won’t be able to
lie to anyone (including yourself).
•••
My friend Anjanette is the sarcastic sort, and she likes to tell a funny story. But
when she came to the end of her tale about Camp Widjiwagan, her tone changed.
We had been talking about this book, and about how I had already decided I
wanted her to let me share her story with you as an example of how
accountability groups can help people stick with the program. She agreed and
said, “You know, Mike, I joked about it, but the thing is, that trip to Camp
Widjiwagan changed my life.”
When I asked how, she explained that she had always been the pudgy girl—the
kid picked last for teams, the girl who faked a stomachache to get out of running
the mile to save herself the embarrassment of always coming in last. She said
that at Widjiwagan, everything changed. She tried to do every physical task they
threw at the campers, even though her classmates didn’t expect her to do
anything.
“On one of the last nights, they took us on a trail through the woods to this cabin
and taught us about the constellations. Then they said, ‘Now we’re going to
separate the boys and the girls and go jump in a hole in the ice.’ I was
gobsmacked! Apparently we were expected to strip down to our wool socks, sit
in a scorching-hot sauna and then run out in the snow to a hole in the ice where
two counselors would dunk us in the freezing cold lake.
“When the counselors asked who wanted to do it, it was crickets. No one wanted
to try it. I mean, at thirteen years old our first thoughts were probably, ‘NAKED!
WHAT? ARE YOU CRAZY?’ The room was quiet and I thought, ‘Anjanette, if
you don’t do this you will regret it for the rest of your life.’ So ever so slowly I
lifted my hand in the air and said, ‘I’ll do it.’
“My friends were shocked. They thought I was joking. But when I stood up and
followed the counselor to the door, they knew I was serious. Now, because I was
the girl who sat out every game, every run, every tennis match, they all felt
compelled to follow suit. It was an, ‘If Anjanette is doing it, that means we have
to do it’-sort of thing. So in a way, I was their accountability leader. I held them
accountable to the experience and they fell in line.”
Anjanette paused to collect her thoughts. Then she said, “It was amazing, Mike.
Jumping into that hole in the ice, totally naked, not caring what anyone thought
of my body. And being the first one to do it—that was huge. It set the tone for
the rest of my life. I’m a risk-taker now. And it’s partly because I decided to
lead. As a leader, by default I held myself accountable.”
To secure the success of Profit First in your business, to really lock it down and
ensure that your business will be profitable beyond your comprehension, you
must hold yourself accountable to the process by whatever means necessary.
Lead a group or join a group. Either way, you will achieve levels of profitability
you would never hold yourself accountable for alone.
And look at it this way—at least you don’t have to jump naked into a hole in the
ice on a twenty-below-zero, January Minnesota night. Anjanette would tell you
that it’s not so bad, anyway. She’d say, “It’s better than square dancing.”
ACTION STEP
HOLD YOURSELF ACCOUNTABLE
The Only Step: Start looking for a PAG or Profit Pod that will meet your needs,
or start your own. Begin that process TODAY! For a list of PFPs who lead such
groups, or who can help you start one, visit the Resources tab at
www.MikeMichalowicz.com. No matter what, don’t go it alone; it’s much easier
to stay the course when you do it with others.
CHAPTER
Techniques
NINE:
Profit
First
—
Advanced
When folks first join Weight Watchers, they set a goal of losing 10% of their
body weight. Even if you weigh 300 pounds and have to lose another 150 to get
down to your ideal weight for optimal health, you still only set a goal of losing
30 pounds. The strategy is to string together a series of small wins and build
momentum, plain and simple; and it’s the reason why Weight Watchers has such
an impressive success ratio compared to other diet programs. With 10% of your
body weight kicked to the curb you can focus on the next 10%, and then the next
until you get down to your ideal weight.
If on the other hand you focus on the target weight loss goal of 150 pounds from
the get-go, you will likely become discouraged and give up; it takes a long time
to lose an entire person! Massive goals feel exciting when you declare them, but
can quickly become de-motivating factors because they seem so hard to reach
and the chance to celebrate is so far off in the future.
You’ll see a lot of formerly overweight and obese people getting into running
marathons and triathlons and other extreme endurance races and sports. Do they
start this way right out of the gate? Heck, no. They start with a walk around the
block. Then a longer walk. Then maybe a walk-run cycle. Then maybe they sign
up for a 5K.
Small wins lead to big wins, and if you started implementing Profit First back in
Chapter 3, you already know that. You lost your 10% and ran your first 5K. Now
you’re ready to take on the advanced stuff . Like a dieter who recently
completed a few small goals, your business is healthy enough to take on bigger
challenges, now, much healthier than it was before you first cracked this book.
Here’s the deal: you are about to learn the Profit First equivalent of running your
first marathon. You need to be in shape and all stretched out before you do it. So
please do proceed with reading, but don’t implement this stuff until you have
completed at least two full quarters with the core stuff you learned about Profit
First. Are you making your biweekly allocations? Are you amassing some profit,
no matter how small? Have you experienced a few profit distributions? Are you
participating in some form of PAG? If you answered yes (a real yes) to all four,
if you’ve mastered not breaking the rules, you’re good to put on your running
shoes and move forward.
ADVANCED SIMPLIFICATION
A few years after implementing Profit First for myself, I realized that I could
really take my money management to the next level if I tweaked my system
further. The stuff I taught you in the beginning of this book was working well,
but there were certain times I still needed to do the accounting work to
understand the financial health of my business. Sometimes my deposits weren’t
made as a result of sales; they were simply reimbursements for expenses. Other
times, a client paid a wad of cash up front for work that I would do in dribs and
drabs over the next year. Sometimes I needed to make big purchases, and I
wanted to save for them. Mine wasn’t the only business that needed tweaks;
everyone I consulted with needed them. So do you. And the process is simple.
You need just a few more accounts.
While it may not seem like opening additional accounts simplifies anything, it
absolutely does. Whenever you can get a clear, accurate picture of how much
you have to spend on a specific aspect of your business, you will make better
decisions and be less likely to commit to projects, vendors and expenditures that
do not fall in line with the balances in those accounts. Likewise, if you know
exactly how much cash is flowing into your business at any given time, you can
make better decisions about where you need to focus your efforts.
You already have your four foundational Profit First accounts open—Profit,
Operating Expenses, Owner’s Pay and Tax—plus your two no-temptation
accounts that don’t get touched, the Profit and
Tax Accounts in a separate bank. Here are the additional accounts, contingent on
your business needs, that I recommend you consider opening:
INCOME ACCOUNT
This is probably the most helpful and important account for advanced Profit
First. I can’t imagine your business not benefiting from it. In this account, you
collect all of your income deposits so that you can clearly see how much cash
you collected between your 10th and 25th allocations. This will separate
incoming from outgoing cash, both of which were being managed by the
Operating Expenses Account in the simple version of Profit First.
An Income Account will give you an accurate picture of how much money you
collected during any period of time. And the Operating Expenses Account will
transition to only paying the expenses for operations, so you will have an
accurate picture of how much money is flowing out of your business at any
given time.
It’s critical that you adjust to your Real Revenue. If you have material and
subcontractor costs, allocate these fixed amounts first, before you do the
percentage allocations. Then, on the 10th and 25th of every month, allocate all
remaining money in the Income Account to the other accounts: Profit, Owner’s
Pay, Taxes and Operating Expenses. And possibly a few others suggested below.
THE VAULT
The Vault is an ultra low-risk, interest-bearing account that you can use for
short-term emergencies. At a certain point, leaving 50% in your Profit Account
to act as a rainy day fund is not prudent since the money flow is a little
unpredictable. A bad quarter won’t contribute much to the Profit Account. Then
you take 50% out for a profit share, and now that Profit Account reserve might
be too small for a big business. Every business should have a three-month
reserve, meaning that, if not a single sale came in, all costs could still be covered
for three months (a quarter). The question isn’t if you will have a dark day (your
supplier goes out of business, your biggest client goes bankrupt, your best
employees leave to start a direct competitor and your clients decide to go with
them, etc.). The question is, when will your dark day come? The Vault is there
for that.
When you set up The Vault, you must also establish certain rules for its use.
What I mean is that, when you have a situation so dire that you need to access
this money, you also have instructions written in advance on how to proceed.
For example, if the money is pulled due to a drop in sales, you will pre-plan that,
besides just trying to get more sales, you will also cut all the related costs in your
business within two months if things haven’t improved. Few people have the
discipline to think clearly or act appropriately in times of panic, and that’s why
we document a simple set of instructions for ourselves in advance.
The idea behind The Vault and the entire Profit First system is that it puts your
decisions well out in front of any money crisis. Your business dynamics may
not, in fact, improve; but your decision-making will be much farther out in front
of the actual financial impact. So the goal of The Vault is not to buy time; it may
afford some time to address unexpected challenges, but it is really about forcing
important decisions early, so your business doesn’t go into a cash crisis (you
know, back to the Survival Trap).
STOCKING ACCOUNT
This is an account for big purchases and to fund stocking parts of your
inventory. For example, remember my friend JB? His roof decking company,
RoofDeck Solutions, Ltd., sells the materials contractors need to complete their
projects. JB includes some basic nuts and bolts with each order, usually fifty or a
hundred of each; yet his supplier requires a minimum order of ten thousand at a
time, which costs JB roughly $5000. Each order will last JB ten months or
longer, so he set up what he calls a “large purchase account” into which he
allocates 1/20th (that’s $250 each time) of the funds he will need for the next big
nuts and bolts purchase. Why 1/20th? Because he knows he’ll need the next
order in ten months, and he is on the 10/25 Rhythm. Ten months, two times a
month, equals twenty allocations before the next big purchase. By doing this, JB
is able to chip away at the big bill before it happens. Then, when it’s time to
cough up the $5000 for the next big nuts and bolts order, he’s ready. In the past,
this bill caught him off guard and he had to scramble to cover it. Now, he barely
feels the $250 he allocates to his Stocking Account twice a month.
PASS-THROUGH ACCOUNT
Some businesses receive income from customers that is not to be allocated for
Profit or Owner’s Pay. Sometimes you may provide a service or a product to
your customer at cost (or near cost), and other times you may be reimbursed for
costs outright. For example, I travel a lot for my work and in almost every case
my clients reimburse my travel costs. That income is not allocated to cover
payroll or added to my Profit Account. It’s a pass-through and goes directly into
this account, and then off to the corresponding vendor to pay the bill. If I have
paid the bill in advance, the money is deposited into the Pass-Through Account
and then transferred (on the 10th or 25th) to the Operating Expenses Account,
from which I paid the initial bill. By the way, with all these advanced accounts,
the nickname you give each is entirely up to you. I call this one my
Reimbursement Account.
MATERIALS ACCOUNT
If most of your revenue (as indicated in the Instant Assessment) falls into top
line revenue and does not flow through to Real Revenue, then most of your
income is pass-through revenue and the core of your business is basically the
management of that pass-through. If this is the case, set up a Materials Account
for the money that is allocated specifically for purchase of materials. Do not
allocate it for anything else. (Ever!) If for some reason there is money left over
at the end of the quarter (in other words, you had a larger profit margin than you
expected), you can move that balance to your Income Account (or Operating
Expenses Account, if you aren’t doing advanced Profit First yet) and make the
allocations accordingly. The Materials
Account functions in the same way the Pass-Through Account does, but it is
broken out separately so that you know its exclusive purpose is for materials.
SUBCONTRACTOR/COMMISSION ACCOUNTS
If your business does not purchase materials, but uses contractors or people paid
on commission instead, this is where you allocate the funds to pay these fine
folks. Treat it just like the Materials Account, but apply it to contractors and
commission-based team members.
EMPLOYEE PAYROLL ACCOUNT
Employee pay is relatively predictable—full-timers are on salary and parttimers, for the most part, work an average number of hours per week. This
means you can look at the cumulative gross pay for your employees plus the
payroll taxes you’ll incur and allocate funds from your Income Account (if you
use advanced Profit First) or Operating Expenses Account (if you use basic
Profit First) to the Employee Payroll Account every 10th and 25th. If you use a
payroll service, set them up to pull the payroll from this account (not your
Operating Expenses Account).
MAJOR EQUIPMENT ACCOUNT
Similar to your Stocking Account, this account is for big purchases you may
need to make farther down the road, such as new computers or a high-end 3-D
printer. Estimate how much you might have to spend on future equipment
purchases, divide it by the number of months you have to save up for it, divide
that number by two and allocate that amount every 10th and 25th to accumulate
enough money for that big purchase.
DRIP ACCOUNT
This account is for retainers, advance payments and pre-payments on work your
company will complete over a long period of time and for which you have yet to
expend resources. Say you get a big project (congratulations, by the way), and
you receive $120,000 from the client
up front for work you will complete every month over the period of a year. That
means that each month, you will really be earning $10,000. So when you get that
check, put the $120,000 into the Drip Account and then automatically transfer
$10,000 to the Income Account every month (or better yet, $5,000 every 10th
and 25th). You don’t touch any of the balance in the Drip Account. You only
make allocations when you drip a portion of the funds—in this case, the $10,000
each month—into the Income Account.
The Drip Account will help you manage the true cash flow of earned money, so
that you can manage your expenses and costs. For example, the labor doing the
work will be paid monthly. I helped implement a Drip Account with my friends
at TravelQuest International in Prescott, Arizona. They provide their clientele
with once-in-a-lifetime trips, from viewing solar eclipses from the best vantage
points in the world, to visiting the South Pole to see the Aurora Australis, to
experiencing zero gravity in outer space. People book these trips up to five years
in advance, while the majority of the company’s expenses occur during the year
of the event. Enter the Drip Account.
PETTY CASH ACCOUNT
Set up a bank account and get a debit card for petty cash purchases, such as
client lunches. Then, allocate a regular dollar amount from your Operating
Expenses Account to petty cash. Me? I allocate $100 every two weeks for
myself, and also for a few employees who need it. The funds cover gifts, lunches
and other small purchases. Sorry—if I’m buying, we likely aren’t having an
eight-course meal. . . if it’s not in my Petty Cash Account, it ain’t in my budget.
SALES TAX ACCOUNT
If your business collects sales tax, every single, stinkin’ penny of the sales tax
you collect is immediately allocated to this account. For example, if you sell
something for $100 and sales tax is 5%, you will deposit $105 into your Income
Account. First, transfer that $5 into your Sales Tax Account; then do your Profit
First allocations with the remaining $100. Sales tax isn’t even legally your
money; you are just acting as a collection agent for the government, so never,
ever treat that money as income. Just bang people over the head for the sales tax
and turn it over to the king (the government).
Figure 7 is my own account setup. The account numbers are made up, of course,
and the balances are not my real numbers. But they do show a very typical
breakout of the cash, and the names of the accounts are the real names I have
assigned to my accounts. Next to each name, in parentheses, I put either the
dollar amount or percentage that goes into each account at the allocation times
(the 10th and 25th). You should do the same.
Looking at the numbers, I can see instantly where my business stands. I can run
an Instant Assessment at any time. For the purposes of this example, I set my
required personal monthly income at $10,000 per month. From there I can
instantly calculate the total business income I need to make between every
allocation period.
WRITE DOWN THE PROCESS
Create a single-page document that defines the function of each account. Explain
what purpose each account serves, and the process you will follow. For example,
document that, on the 10th and 25th of the month, all the money in your Income
Account is distributed to the Profit, Owner’s Pay, Tax, and Operating Expenses
Accounts based on the respective percentages. Then, the specific dollar amounts
— $75 for Petty Cash and $1500 for Employee Pay—are transferred from the
Operating Expenses Account into the respective accounts. Finally, the total
money in Bank 1’s Profit and Tax Accounts are transferred to Bank 2.
This process is a system, so it needs to be documented. Your bookkeeper might
have to take this over for you; otherwise, you might drink too much one night
and forget the rules you set up for your accounts. Heck, you could end up
allocating all of your money to your Erik Estrada Fan Club fund, a fan club of
which you are the only member (even Erik dropped out).
PICK YOUR PAY TO FIND THE NECESSARY BUSINESS INCOME
The famed “monthly nut” is a horrible distraction. It’s up there with reruns of
Jersey Shore. The monthly nut is a remnant of the GAAP mentality that simply
tells us the number we need every month to keep the doors open. And that is
nonsense. The “monthly nut” is a focus on—you guessed it—expenses, not
profit. The concept of the monthly nut makes you focus on expenses and do
everything you can to earn your “nut” with enough sales. In other words, it has
us put costs first and makes the goal to cover expenses, not to improve
profitability. Can you say “Survival Trap?” Good. I knew you could.
You get what you focus on, so stop focusing on expenses. Focus on profit and
the expenses will be taken care of by default. Screw the “monthly nut.” Instead,
focus on your Required Income For Allocation (RIFA). This is the money you
need to deposit by the 10th and again on the 25th to have a healthy business, to
pay the salary you want from your business and to take the profits you deserve.
Period.
Take your monthly, required personal income and divide it by two, since you are
getting paid twice a month. Then divide that number by the percentage being
allocated in Owner’s Pay. Using the (made up) amounts on Figure 7, I would
divide $5000 by 0.31. The result is just over $16,000 in business income, which
means that by the 10th and 25th of every month I need to collect and deposit
around $16,000 into the Income Account to cover it. It’s really that simple.
So when I look at my Income Account (above), I know instantly that I am
currently falling short by $3000 and need to keep the sales moving. Every two
weeks the Income Account drops to zero when it is allocated, and I need to
rebuild it to $16,000 or more. Yes, there is a nice chunk of change in my Drip
Account; but that money is for services I will render over another twelve
months, so it will only account for about $1000 every allocation period. Using
this system, my sales revenue minimum becomes very, very clear.
WHEN YOU HAVE MORE THAN ONE BUSINESS OWNER
Just one more point about Owner’s Pay: If you have a partner or multiple
partners who are also getting paid, you need to add up the total income
requirements for the company. So if you need $10,000 a month and your partner
also needs $10,000, the total owner pay is $20,000 per month. Divide that
number by two; then divide again, by 0.31, and you get an RIFA of more than
$32,000.
You may also notice that the Profit (15%) Account with Bank 1 is at zero. That
is because it is simply a holding tray for a day or two. Money gets allocated from
the Income Account and goes to the Profit (15%) Account at Bank 1. Then, on
the same day, I initiate a transfer to Bank 2, to pull the entire amount of money
out of the Profit (15%) Account at Bank 1 and put it into the Profit Account at
Bank 2. That is where the profit accumulates. And I can see, it looks as though I
will have a really nice, $7000-plus profit celebration at the end of this quarter.
It’s a simple calculation: $14,812.11 x 50%. Par-tay!
This same holding tray setup is in place for my Tax (15%) Account. Allocate
and then remove the temptation immediately.
Also, you may notice that no bank summary “grand total” is shown in the table.
The accounts aren’t all automatically added up to show a total combined
balance. Many banks do this for your convenience, but I suggest that you disable
the option (if you can). The grand total of all your accounts shows you all the
money on one big plate again— exactly the thing we want to avoid. Looking at a
grand total messes with your mind, so don’t do it.
THE PARETO OVERLAP
You may be familiar with the Pareto Principle, commonly known as the “80/20
rule.” For the history buffs: Vilfredo Federico Damasa Pareto was an Italian
economist. While studying the distribution of wealth in Italy in the late 1800s, he
discovered that 20% of the Italian population owned 80% of the land. Then he
looked at his garden, and observed that 20% of the peapods contained 80% of
the peas. Then he looked down at his feet, and exclaimed, “OMG—I own five
pairs of clogs, yet I wear these super-fly boots 80% of the time!” And then, out
of nowhere the theme song from The Twilight Zone started playing, thus
marking the first time that music was associated with a slightly unsettling a-ha
moment.
Okay, okay. I made up that last part, but you get my drift. Pareto’s pattern is
everywhere. Eighty percent of the time you drive, you’re cruising down the same
20% of the roads you’ll travel in life. And, despite your love of the sale rack,
you will still pull from the same 20% of the clothes hanging in your closet, 80%
of the time. Chances are, you are wearing one of your fave pairs of pants or
shoes right now, as you read this. You are, aren’t you? That’s Pareto’s rule at
play in your own life. Cue Rod Serling and a smoldering Chesterfield cigarette.
Pareto’s Principle also applies to your clients, in that 20% of them yield 80% of
your revenue. This is a foundational principle of the growth strategy I detailed in
my book, The Pumpkin Plan. And it goes further—80% of your profit is derived
from 20% of the products and/ or services you offer.
The key to this advanced strategy is to connect the two—your clients and your
offering. Some of your top clients buy most of your profitable offerings; some of
your top clients go for the offering with the lowest profit margin. Likewise,
some of your weakest clients consistently purchase your profitable stuff and
some are just weak all the way around, buying the same no-profit stuff over and
over again.
Once you see the overlap, the decisions become very easy. Get rid of the “bad”
clients who only want your least profitable products and services. You are losing
money here, catering to clients or customers who are not a good fit for your
company.
Find a new way to manage the weak clients who do buy your most profitable
offerings. Often, “bad” clients can become better clients if you meet with them
to set new expectations and methods of communication. Meet with your top
clients who don’t buy profitable offerings, too. Find out how you can deliver
profitable stuff to them.
When you focus on profit first, even when choosing the clients and customers
you are willing to work with, you increase your profit dramatically. Not only do
you save money by cutting expenses related to serving weak clients, who don’t
buy profitable offerings; you also free up your time, energy and creativity to
focus on the clients you love, who bring in the profit. Applied to your client
base, the Pareto Principle is an advanced Profit First technique that does double
duty— you save money and gain profit. Gotta love that!
And those beloved top clients, who routinely buy profitable offerings? You are
going to rock their world. Get to know them better than they know themselves.
These are the clients and customers you want to clone. Remember, profit is in
productivity. Systematize the overlap of your best clients buying your most
profitable offerings and watch your Profit Account grow by leaps and bounds.
EMPLOYEE FORMULA
There is a really simple formula for determining if you can afford a new hire—or
if your business is currently understaffed or overstaffed. For each full-time
employee, your company should generate Real Revenue of $150,000 to
$250,000 (ideally more, but this is the minimum). So, if you want a milliondollar company, you know that you can afford four to six employees (including
yourself). This is just a ballpark number; every business is unique. But do not
use your super distinctive status as an excuse to hire more people.
Efficiency is always the goal. Always. Not hiring your husband’s cousin who is
down on his luck and “could really use a job.” Not finding space for the brilliant
kid who has a ton of great ideas you could use… someday. You’re a “bottom
line” person now, remember? You flipped the formula. Now, you’re working the
“Sales – Profit = Expenses” system. You’re taking profit first. And that’s why
you’re forced to be careful with your expenses.
And remember—we’re talking about Real Revenue, not top line revenue.
Subtract your Material and Subs cost before you divide by the magic number
range to get to your ideal employee count.
Again, this is not an exact, perfect system, but it will give you a better and more
realistic understanding of what it means to be over-or understaffed. The reason
these numbers aren’t perfect is because labor costs vary tremendously. A guy
cooking French fries at McDonalds will make much less than the lady who
engineered the next generation smartphone. In this example, cheap labor is less
costly but also has a smaller impact on revenue. The fry guy just facilitates that
sale of fries, and the engineer creates an entirely new product and revenue
stream.
Remember Greg Crabtree, the author of Simple Numbers, Straight Talk, Big
Profits whom I met an entrepreneurial award event? I had a call with him one
evening. After he poked fun at Virginia Tech (my alma mater) losing to
Alabama (his alma mater) yet again, he shared another instant labor analysis he
agreed to let me pass on to you.
According to Greg, your Real Revenue must be two-and-a-half times the total
labor cost if you’re running a tech business. This is because the tech industry
traditionally requires expensive labor (highly-trained people who have a big
impact on revenue). If, on the other hand, you are in a “cheap labor” field, such
as the fast food restaurant example I used above, your Real Revenue must be
four times your total labor cost.
For example, let’s say you’re a manufacturer with $6,000,000 in Real Revenue.
If you hire “cheap labor” (like assembly line personnel), you will divide
$6,000,000 by four to get $1,500,000. This means that your total labor cost (the
people on the floor and the folks in the office) should not exceed $1,500,000.
And if you are a manufacturer with $6,000,000 in Real Revenue but use
“expensive labor” (like scientists and engineers), divide the $ 6,000,000 in Real
Revenue by two-and-a-half to get a total labor cost of $2,400,000.
MINI POWER TACTICS
Some advanced Profit First strategies require very little time and are super
effective. I am constantly tweaking and improving my system, so if you want to
know about my latest discoveries, and share yours, visit my blog at Mike
Michalowicz.com. Here are my favorites (so far):
THE GOVERNMENT’S MONEY
It’s so easy to “borrow” from our Tax Account. (It’s really stealing, but you
don’t need me to tell you that… oops. I just did.) The money is just sitting there,
taunting us with all of those zeros we could put to good use. When we cave and
pull from the Tax Account, we don’t feel the pain right away. But when tax time
comes, we can get in really big trouble. Owing more taxes than we have money
to pay means that, at a minimum, we’ll be paying interest and possibly penalties
on the amount we owe.
A smart tactic is first to move this account to a third-party bank that you don’t
see, and then change the name of the Tax Account to
“The Government’s Money.” Now, I suspect that, like me, you would be way
more reluctant to “steal money from the government” than you would be to
“borrow money from the Tax Account.”
HIDE ACCOUNTS
Following the “out of sight, out of mind” theory, you are less likely to justify
transferring or withdrawing funds from your accounts if you can’t see them.
Some banks allow you to “hide” accounts so that you can’t see them on first
view when logging in to online banking. Try hiding all of your accounts except
for the Operating Expenses Account. You can still do the disbursements and the
entire Profit First system using this tactic; it just means that now you won’t
consider the other accounts when making spending decisions.
OUTSIDE INCOME ACCOUNTS
Chances are that as your business matures, you will add a variety of other
accounts that collect income. You may have a PayPal account to collect funds,
or a wire account for international business or local transfers. The challenge with
these accounts is, you might start to view them as “extra,” like your own
additional petty cash fund. They’re not extra. They are part of your revenue, and
you need to make sure that you protect and allocate the funds just as you would
any deposit into your main bank account.
For this tactic, set up all your outside income accounts so that any income is
transferred to your main Income Account on a daily basis. Some banks will let
you set up an auto-transfer for the total balance in the outside account, which is
ideal as long as you keep whatever minimum balance is required to avoid
extraneous administration fees.
If you can’t do this automatically, simply transfer the money to your Income
Account when you do your biweekly allocations. Just note that these transfers
may take a few days, so you won’t instantly have the money in the Income
Account and will have to wait until your next allocation period to move the
money to all the individual accounts.
ACCOUNT SNAPSHOT
To keep track of your accounts, set up auto-notifications for your key accounts
via email or text. Have the bank report the balances of your Income Account and
Operating Expenses Account to you on the 10th (when all of your money has
accumulated) and the 15th (when all of your money has been allocated and all
checks have been mailed; and again on the 24th (accumulated) and the 30th
(allocated). Set up a daily notification of the balance in your Petty Cash
Account. Check the other accounts manually.
This quick report will ensure that you are acutely aware of how cash flows in
(Income Account) and what is available to go out of your business (Operating
Expenses Account) and out of your own spending allotment (Petty Cash).
BANK CHECKS
Until we see that a payment has cleared, we still think of the money is ours. And
sometimes we forget we wrote the check. Hello, insufficient funds charges and a
ticket straight to the ninth circle of hell. This technique changes that dynamic
immediately. Rather than pay with checks you write by hand and mail (if you
don’t lose the envelope on the floor of your car), pay with bank checks.
Also called “bank pay” or “bank payment processing,” bank checks are
processed by your bank quickly. More importantly, the bank will pull the money
for the checks you “write” immediately. This way, you know the money is gone
forever as soon as you process a payment.
Yes, the bank makes money on “the float,” and you lose any interest you may
have earned in the few days it would take your payment to be received and
processed by vendors. But I say, “Who cares?” Here’s the dealio: If you manage
hundreds of millions or billions by processing checks and transfers manually, it’s
a good strategy to cling to your money for a few days because the interest earned
on your operating capital in even just a few days is significant. But for most
entrepreneurs, the interest earned in “the float” is embarrassingly negligible—
usually around $5 per year, and you’ll spend more than that on postage, mailing
out your payments! So let the bank do the dirty work, why don’t ya?
ACTION STEP
PLAN TO ADVANCE
Choose one of the advanced tactics or strategies detailed in this chapter and add
it to your to-do list for six months from now. It may seem silly to add a to-do
item so far out, but if you don’t put it on your radar, you may end up forgetting
that there are advanced strategies that could help you take Profit First—and your
company—to the next level.
CHAPTER TEN: Living Profit First
I’m going to Disneyland!
It’s the iconic moment—a sports team wins the championship game and the field
reporter rushes over to the star player to ask the same old question: “Hey, giant
football guy, you just won the Super Bowl. What are you going to do now?” The
player smiles, showing a big gap in his teeth, stares right into the camera and
shouts, “I’m going to Disneyland, mother@#$%&!” The station beeps out the
@#$%&! part. Barely.
I thought about this phenomenon during a recent conversation with Laurie Udy,
accountant and owner of Secretly Spoiled, a company that recently started using
Profit First. She shared with me that she took her family on their first Disney
vacation using her quarterly profit disbursement. A type-A numbers person,
Laurie had been investing everything she had in her business—most of her time
and all of her revenue.
“I was living check-to-check,” Laurie told me. “I wasn’t taking a salary.”
All of that changed as soon as Laurie started plugging Profit First into her wellorganized system. Within months, her personal finances stabilized; and by the
time her first quarterly disbursement came around, she had enough to take her
family on their first trip to Disneyland.
“The trip was amazing, and we’re already planning the next one,” Laurie said.
“But what really surprised me was, after funneling all of my money into my
business thinking that it was the only way to make it grow, my business actually
started to grow faster when I started paying myself and focusing on the profit
first!”
Like so many of us used to “doing anything” to build our businesses (including
going without pay and delaying profit indefinitely), Laurie had to learn how to
give herself permission to use her hard-earned money not only to pay herself, but
also to enjoy herself—to provide experiences for her family that would enhance
their quality of life and create a lifetime of treasured memories. The business
was no longer a cash-eating monster. Not even close. It said, “Bon Voyage!” to
Laurie and her family as they cruised off to Disneyland, mother@#$%&!
This won’t come as a shock to you: Everything you just learned about creating a
Profit First business also applies to your personal life. I mean, if you think about
it, running your life is like running a business. You generate income and spend
money. Your income likely varies at times. You never know when a crisis might
hit and make a huge dent in your bank account. And you have a vision for your
life, just as you have a vision for your business—one that, before reading this
book, you may have thought hinged on a lucky lottery ticket or some other
sudden windfall.
Now you know better. You know that in order to save enough money for a rainy
day and the celebratory pleasures of life, you need to pull that money out before
you spend a dime on other things. You know that a smaller plate will help you
trim the fat from your lifestyle and zero in on what’s most important to you and
find fun, creative solutions to get what you want. And you know that the big
vision you have for your life does not have to hinge on luck or fate—it can be
earned, not with a dollar for the Powerball, but with a simple change in habit,
practiced consistently.
You know what? That’s a big, big deal. And I want to acknowledge it. I want
you to acknowledge it. This small change you made, putting profit first, is the
entrepreneurial equivalent of winning the World Series, the Super Bowl and
Stanley Cup. You created the miracle that is your business and now, by
implementing the Profit First system, you have ensured its greatness—not just in
terms of profitability, but also in terms of the positive impact your business will
have on the world.
So guess what? It’s time to get your gappy, toothy smile on. You’re going to
Disneyland! Let’s apply your championship-winning strategy to the rest of your
life, okay?
THE PROFIT FIRST LIFESTYLE
The ultimate goal of the Profit First Lifestyle is financial freedom, which I
define as doing what you choose to do whenever you choose to do it. Financial
freedom means that you have reached a point where the money you’ve saved
yields enough interest to support your lifestyle and continues to grow. The path
to financial freedom is paved with simple, small habit changes that become
systematized and apply to both your business and personal finances.
Now, I did not write this book to teach you about your family budget or your
401K, but I do know this: If you own a business, your personal financial health
is in lockstep with the financial health of your business. In fact, the analogy of
your business being your child is only partially accurate. A better analogy is that
your business is your Siamese twin. Separating yourself from it must be done
with absolute surgical precision, and even if the operation is successful you will
always share a soul.
So, soulmate, you need to apply everything you’re doing right now (and
planning to do) to fix your business with Profit First to your life, too. I wrote this
chapter to serve as a take-action-now primer on living a Profit First life. I
suggest you also read David Ramsey’s The Total Money Makeover. If there is a
Bible for getting your personal finances lined up the right way, I believe his
book is it. And who knows, maybe down the road I will write my own “New
Testament.”
That said, here is the core stuff you need to know about setting yourself up to
live a Profit First life:
1. Face the music. This step should be easier now that you’ve faced the
truth about your company’s finances. Add up all of your monthly bills,
plus your annual bills and the debt you owe.
2. If you have any debt at all, stop accruing more. Put a freeze on all
purchases you cannot pay for with cash.
3. Establish a personal Profit First habit. Set up an automatic
withdrawal so that every time you get paid, which should now be
twice a month on the 10th and 25th, a percentage immediately
transfers into a retirement savings account. If you are carrying any
amount of debt, keep the retirement percentage at 1% until the debt is
paid off. Use every penny you have after necessary expenses to
eradicate your debt.
4. Set up your “small plates.” Create four core accounts and multiple
Day-to-Day accounts.
a. Income Account. This is the account into which you make deposits.
From this account, allocate money to the other accounts.
b. The Vault Account. Initially, this is the “oh shit” account, the
amount of savings you must have on hand to get through the month if
—scratch that— when something dire happens. Now, Suze Orman
recommends saving eight months’ worth of living expenses, but that’s
not doable for basically any human being on this planet, right off the
bat. However, you will work toward it slowly and methodically—you
know, Profit First style.
A good starting balance for The Vault is one month’s rent or mortgage
payment. If you can spare that right now, transfer it to The Vault
immediately. Remember, this account must be difficult to access (e.g.,
different bank, no online banking, no checkbook, etc.). Once you
eradicate debt, The Vault will grow and grow, with the intention of
having the cash you save here eventually become a source of income.
This is where money makes you even more money.
c. Recurring Payments Account. This account is for payment of your
recurring bills, including fixed (e.g., your mortgage or car loan),
varying (e.g., utility bills) and short-term (e.g., an installment plan for
your kid’s braces).
Determine the monthly average for your varying recurring bills, plus
10%. Then total your fixed recurring bills. Add the two totals together
plus the cost of your short-term recurring bills: This is the amount you
will transfer from your Income Account into your Recurring Payments
Account every month. If you have it, transfer that amount now.
d. Day-to-Day Account (multiple, if needed). There are many day-today costs in keeping a family running—groceries, clothes, school
supplies, Girl Scout cookies, date night, running shoes, Girl Scout
cookies, baby-sitting, toiletries, snow tires, Girl Scout cookies. . .
sorry. If there is anything that can take me joyfully down the sugar
high path, it’s the ultimate in sweet delights: Girl Scout Samoas
cookies.
Set up a Day-to-Day Account for anyone in the house who’s
responsible for paying for these types of expenses, and transfer the
amount that each person needs every 10th and 25th from the Income
Account, based on spending requirements. For example, my wife and I
both buy stuff for the house—I’m the Costco king, she handles the
grocery stores. And we both gas up cars and pay for kid expenses. Get
a debit card for each person so that purchases are deducted from the
account immediately.
e. Debt Destroyer Account. This account receives all remaining funds
and goes toward eradicating debt. Following Dave Ramsey’s advice,
make the minimum payment on each debt. Then, regardless of interest
rates (unless they are extreme), pay off your smallest debt first. Wipe
that sucker out and then move on to the next one. Ramsey wisely says
that paying off a debt, however small, creates a mental momentum that
will motivate you to pay off the rest of your debt, faster. Remember,
we are emotional beasts, not logical ones.
If you are carrying debt, I want you to cut up your credit cards. Remember, it’s
much easier to go with human behavior than it is to fight it, so removing
temptation is the best solution.
However, I do have one exception. An entrepreneur’s income can be highly
unpredictable. You could have an amazing month followed by a zero-dollar
month, followed by a not-bad month, followed by a why-do-I-bother month. If
you follow Profit First, your Owner’s Pay Account should address this and your
income should become consistent. But in the beginning, it probably won’t be.
And if you’re a start-up, you may not get any cash at first. For these reasons, I
believe in keeping one credit card line to buffer you in dark months. Put the
credit card in a sealed envelope labeled “emergency only” and give it to a trusted
friend to hold onto. I am serious. You must remove temptation. Here’s how you
manage your emergency credit card the Profit First way:
Every quarter, as you make progress paying down debt, reduce your credit limit
by 50% of the amount you paid down. Say you have a maxed-out card with a
$10,000 limit. By the end of the quarter, you’ve managed to pay down $3000 of
that debt (nicely done, my friend). Now you have $7000 in debt and a $10,000
limit. What I want you to do is call the credit card company and ask them to
reduce your limit by $1500, which is 50% of the amount you paid down in the
first quarter. Now your debt is $7000 and your credit limit is $8500. In doing
this, you put up a guard rail of sorts, a mechanism to protect yourself and keep
your debt total down (should you convince yourself it’s okay to max out your
credit card again), while keeping a credit line buffer in place should you need the
card for emergency funds during slow months.
Keep following this method every quarter until your credit card balance is zero
and your credit limit is $5000. Put that credit card in a sealed envelope and store
it in a safe place (your wallet, it goes without saying, is not safe). Better yet,
have a reliable friend hold onto it for you. This is your emergency line.
Now, for those of you who say, “But Mike, if I drop my credit line, my debt-to-
credit-limit ratios will fall out of favor with lenders and my interest rates will go
up!”
To that I say, “Who cares?”
The goal here is to remove financial stress from your life by eradicating debt, not
to get better rates on more debt. We can worry about improving your credit score
once you are debt free. Remember my buddy Phil Tirone? That’s what he does
now. Once he figured out the formula for becoming debt free, he started
720CreditScore.com, his business that repairs credit scores. Follow suit... first,
destroy your debt. Then, fix your score.
RIP OFF THE BAND-AID
The day my daughter handed over her piggy bank in an effort to help solve my
self-made financial crisis, I still had all three of my luxury cars parked in the
driveway. I was still a member of the country club I never went to and had a ton
of recurring expenses that, quite frankly and even more embarrassingly, I could
not name.
In the weeks and months leading up to that moment, I knew I was running out of
time, but still held onto the trappings of the lifestyle I had earned (but not
“learned”), the lifestyle I thought I deserved and did not want to give up. But my
daughter’s amazing act of selflessness woke me up to the reality that none of that
stuff mattered.
It’s common for us emotional humans to give up the stuff we can no longer
afford (or couldn’t afford in the first place) by small degrees. We cling. We keep
hoping that something will “turn up” and “save the day,” and so we dole out the
pain in small increments, biding our time. We do this because we hate loss.
More specifically, we have a far greater desire to avoid losing something than
we have to acquiring something. This behavioral response is called Loss
Aversion, and it is mighty powerful. Combine it with the Endowment Effect—
the theory that states that we place a much higher significance on something we
possess than on an identical thing that we don’t possess—and you are dealing
with a stubbornness resembling that of a three-year-old in a tug-of-war for a
beloved blankie. (“Mine!”)
For example, the beautiful red Porsche you’ve been eyeing—it would be nice to
have, for sure. But once you have it, it’s way past “nice.” Now, it’s badass (and
so are you). You polish the car. You take friends for rides in it. You take selfies
with that red beauty in the background of each photo (just by chance, of course).
You love it because now that you own it, your relationship to it has changed,
even though it’s the same car you once idly admired from the showroom floor.
Then you get the notice: You missed yet another payment. If you miss one more
they will repossess your baby. Your baby. So what do you do? Return the car?
No, you cancel your daughter’s ballet class (she kinda sucked anyway), and your
gym membership (you kinda sucked anyway), and that trip to the Cape (because
everyone knows, anyone who goes to the Cape sucks… a lot). You eat ramen
noodles every night. Shoot, you even cancel the insurance on the damn car and
keep it parked safely in your garage until “better days” come along. So what if
you can’t drive it? At least you didn’t lose it. At least it’s still yours.
I behaved the same way. I cut back everywhere I could, but nowhere that I
should have. Then, when I couldn’t pay a bill and the credit cards were maxed, I
cut just enough things to get by. The next month it happened all over again, only
worse. Juggling bills and drumming up money were a source of constant stress.
The night after my “piggy bank moment,” I remembered what I used to do in the
past, when money was tightest in the early days of starting up a new business: I
wouldn’t cut expenses in ineffective dribs and drabs. I would cut them all.
It was time for me to return to what worked. It was time to rip off the Band-Aid.
I cut everything. The luxury cars? Gone. (I replaced the three cars with two used,
basic models.) The swanky club membership? Gone. The little extravagances,
like the Netflix account? Gone. And here is what made it easier—I realized that
no one gives a crap. I mean truly, no one cares. I’m guessing you had no idea I
was slashing and burning when I was in the throes, never thought for one
second, “Hey, I wonder how good ol’ Mikey is making out with his financials?”
And I’ll bet you aren’t crying about me right now, either. And that’s cool,
because that’s reality.
When you realize that 99.99% of the people who know you or know of you
won’t care what you own or where you hang out or what your circumstances are,
and that the 0.01% who, for whatever reason, can’t stand you will simply point a
finger at you, laugh evilly and then direct their self-loathing misery at someone
else, it’s easier to ditch the pimped-out ride.
And when you realize that 99.99% of the people who do know you and truly
love you will rally around your courage, as my family did for me, that, that is
when you will stand up, brush yourself off and say, “Let’s do it.”
DEATH TO DEBT
Now, your business will be sending you a quarterly profit disbursement check.
Yippee! Celebration time! And do you know the best way to celebrate when you
have mongo personal debt? Have a death-to- debt party. It’s super fun and goes
something like this: As soon as you get your disbursement check, turn on some
tunage that gets you fired up—my choice would be Metallica’s “Seek And
Destroy,” but if you don’t have a mullet, do your thing. For God’s sake, though,
don’t crank up the Barry Manilow or “Escape (The Piña Colada Song)” by
Rupert Holmes… we want to destroy debt, here, not make love to it.
Then, make sure you have a glass of libation, or whatever floats your boat.
Finally, take 90% of your profit disbursement and use it to pay down debt
(smallest first). Call it in using your debit card, or go online and get it done
immediately. Then, and only then, raise your glass and say, “Cheers to me!”
Then, we dance (or swing our sweaty, stringy mullet hair around while listening
to Metallica). The party is over in about ten minutes, but that debt? It’s gone
forever. Hey, wasn’t that a total blast?
You may think I’m being sarcastic here, but I’m not. To me, paying down debt is
winning, and winning is fun. Get yourself some of those crackers the Brits give
out at Christmas—you know, the little cardboard tubes covered in wrapping
paper that two people pull apart like a wishbone to reveal little trinkets and
revelry inside?—for your party. Invite your spouse. Whatever it takes to
commemorate the occasion. (And if you videotape your tiny death-to-debt party,
send me a link, okay? I want to post the best of the best on my blog.
Use the remaining 10% of your profit disbursement however you please. Go out
to dinner. If you don’t have enough for dinner, go out for ice cream. No matter
what your disbursement is, cherish it. Celebrate with it. Your business is still
serving you and killing debt at the same time.
After you’ve eradicated your core debt—credit cards, bank loans and student
loans—start using 45% of your quarterly profit disbursement to kill remaining
long-term debt and keep 55% for your splurge item or experience. This is
another psychological move. It’s more gratifying to get the bigger chunk of the
fruits of your labor and spend it on whatever the hell you want than to take the
smaller chunk. So use 45% to expedite the payoff of long-term debt beyond your
normal monthly payments (mortgage, car payments) and keep the rest for
whatever crazy antics you get up to. (What? I don’t judge. And I totally didn’t
see anything.)
After you own your cars and home outright and have wiped out debt from every
nook and cranny of your life, one hundred percent of the profit disbursement
goes to you. And this time the party had better be legit. I’m talking a band and
some good booze, maybe stuffed pizza instead of plain. And my wife and I had
better get an invite.
LOCK IN YOUR LIFESTYLE
Remember the graphic in Chapter 2 that showed how our expenses increase at a
parallel to our income? That is the concept of Parkinson’s Law (nothing to do
with Parkinson’s disease), in which C. Northcote Parkinson explained how our
available resources (time, money) expand to fill the space made available for
them. This is why, if you give yourself two weeks to complete a project, you will
get it done in two weeks; but if you give yourself eight weeks to finish the same
project, it will take eight weeks. This is also why, if you have ten dollars in your
pocket, you will spend ten dollars. As our income increases, Parkinson’s Law
takes over and we spend every extra penny we earn.
Now that you know your salary and actually take it, you need to live within your
means. Then, you’re going to lock in your lifestyle. What that means is, no
matter how good things get (and this is going to be a challenge for you, because
now that you follow Profit First things will get amazing), you will not expand
your lifestyle in response. You need to accumulate cash—lots of it—and that
means no new cars, no brand-new furniture or crazy vacations. For the next five
years, you will lock it in and live the lifestyle you are designing now so that all
of your extra profit goes toward giving you that ultimate reward: financial
freedom.
Don’t freak out on me, now. I’m not telling you that you shouldn’t go out to
dinner with your sweetie or go away for the weekend. (Were you thinking a
B&B? I like B&Bs.) You need to enjoy life. I get it. What I am telling you is, in
order for Profit First to have a permanent impact on your life, you need to build
as big a gap as possible between what you earn and what you spend. The more
cash you can collect the better, because at a certain point money starts earning
you substantial money, all by itself. Money yields interest and returns from
investments. And remember, once the money you have collected yields more
new money every year than you spend in a year, you have achieved financial
freedom.
Here are five rules to help you stay locked in to your lifestyle for the next five
years:
1. Always start by looking for a free option.
2. Never buy new when you can get the same benefit you would if you
bought used. (It’s used as soon as you buy it, anyway.)
3. Never pay full price if you can avoid it.
4. Negotiate and seek alternatives first.
5. Delay major purchases until you have written down ten alternatives
to making the purchase and have thought each one through. Save your
splurging for Profit First quarterly disbursements! Yay!
The Profit First Lifestyle is a frugal lifestyle, for sure. But the frugal lifestyle is
not the same as a cheap lifestyle. You can and will live very well (actually
better) when you are frugal than you would when you are posing as a big
spender. Why? Because frugality removes financial stress, enabling you to better
appreciate and enjoy the things and experiences you purchase. Big spenders buy
the same things, but their purchases are served with a big ol’ heaping serving of
massive stress. Who’s got time for that? Remember, well-dressed poverty is still
poverty.
If staring down the next five years is too much for you, that’s cool. I have a Plan
B for you. (And if you do rock the five years, this is your next step after your
locked-in lifestyle term is up). It’s called the Wedge Theory, a term that has been
floating around entrepreneurial circles for a while, which as far as I can tell was
originally coined by Brian Tracey. The idea of the Wedge Theory is to only
gradually (and mindfully) upgrade your lifestyle as your income increases.
Every time your income increases, you set aside half of the increase in savings
so that you don’t expand your lifestyle to, as Parkinson’s Law suggests, “use all
available resources.”
So for example, if you’re taking home $100,000 (post-tax, paid by your
business) and your Profit First Lifestyle means you’re setting aside $20,000
every year and living on $80,000; this is where you will start your wedge. Half
of every income bump over and above $100,000 will go directly into The Vault.
The Vault starts piling up cash, and changes from a “Holy crap, I have no
money” fund to a “Holy cow, that’s a lot of money” fund.
Let’s say your take-home income goes up to $135,000, an increase of $35,000
over the previous year. You would take 50% of the $35,000 ($17,500) and drop
it into The Vault. This leaves just over $117,000. Because you live the Profit
First Lifestyle, you now take 20% and set it aside for savings. With the increase
in income, that number is now $23,400. That brings your annual savings up to
right around $50,000. And, you are now living on more as well—$93,600, to be
exact, an increase of more than $13,000. Your life moves forward, but the
Wedge Theory, combined with Profit First, allows your savings to climb super
fast, getting you that much closer to financial freedom.
PROFIT FIRST KIDS
When was the last time you got a chunk of free money? The answer is never.
And even if you were granted money (thanks to old great-gramma Sally), there
is always a tradeoff. Regardless of how you get your money, the universe seems
to find a way to make us earn it. This is why I don’t gift my kids an allowance.
Instead, I set up a chore list with corresponding pay rates and post it on the
refrigerator. (You can download one from the Resources section at
MikeMichalowicz.com.) The kids decide how much they earn, by working for it.
Give your kids some mailing envelopes (you know, the snail mail type) and have
them label each one:
1. One for the big dream, like my daughter’s horse. Have them stash
up to 25% of their chore money in this envelope.
2. One to help support the family. This number should be a recurring
number, such as $5 a week to contribute to groceries or entertainment.
The key is to have a recurring fee so they get used to having to pay out
something on a regular basis. Make sure the number is ageappropriate.
3. One for impact. Have them put 5 to 10% into this envelope to give
to a charity of their choice, or to use in a meaningful way… like
starting their own business, one that both serves the community and
makes money!
4. One for The Vault. This is where they will sock away 10% of their
funds for a critical emergency (hopefully your kids will never have
one, but you want them prepared from day one), which will also
become an investing source as the money accumulates.
5. One envelope for mad money, to buy whatever they need or want—
toys, music, books, etc. Let them earn money and have fun!
I mentioned my barber Lou in the Introduction. He is the master of the envelope
system. He divides every day’s take among envelopes appropriate for his
business. His shop has been profitable every single month for decades and he has
no debt (except he owes me a haircut for mentioning him in this book).
It goes without saying that the kids must follow the Profit First golden rule:
Always allocate the money to the different accounts (envelopes) before doing
anything else.
This system will teach your kids so much about the value of money—how to
manage it, how to earn it, how to finance their dreams. It may feel strange at first
(I’m talking to you, helicopter parents), and you’ll surely get some pushback; but
this is a massive gift to them. Imagine how your financial life might have turned
out differently, had someone taught you these important lessons and strategies?
Or, if you are lucky enough that your parents did, just think about how well it
served you and do the same for your kids.
Giving your kid a car may feel nice to you, but it’s selfish as hell. You are only
avoiding “disappointing” your children when you indulge them and make their
lives easier, and this only hurts them when they enter the “real world”
completely unprepared for reality. Let your children get burned a little within the
safety of your parenting, rather than scorched in the unsafe and often cruel
world.
•••
One of my favorite Profit First Lifestyle nights was when my wife and I and two
of our friends went into New York City to see Jimmy Fallon at his former show,
Late Night with Jimmy Fallon. The tickets were in a lottery and we happened to
get them. We saw the show live, and laughed and laughed. Meatloaf opened the
show and Twisted Sister ended it with a rocking three-song mini-concert. Seeing
Jimmy Fallon cost a whopping zero dollars. Watching Dee Schneider bang out
“I Wanna Rock” cost zero dollars. In the words of the famous commercial: “An
amazing night out with my wife and friends? Priceless.”
Here’s the deal—living the Profit First life does not have to be excruciatingly
painful. I’m not suggesting that you sell everything and live in a hut, work by
candlelight and eat whatever you can find on the forest floor. I’m not even
suggesting that you give up the things you love. I’m simply suggesting that if
you want true financial freedom, you will have to let go of your preconceived
notions about what you “need” and start placing a higher value on financial
independence than you do on your stuff. It’s not rocket science. And it won’t kill
you. Promise.
ACTION STEPS
LIVE PROFIT FIRST
Step One: Set up corresponding Profit First allocation accounts for your
personal expenses.
Step Two: Based on your most recent pay and the “lifestyle lock” explained in
this chapter, figure out how much you should truly be living on.
Step Three: Have a sit-down with your entire family and talk numbers. Tell
them what you’re doing with Profit First and the positive impact it will have on
your family’s long-term financial health. And if it helps, you can tell the kids
that this method was something suggested by “Uncle Mikey.”
CHAPTER ELEVEN: Where It All Falls Apart
In the spring of 1954, the notion of any athlete running a mile in less than four
minutes was considered impossible. Four minutes was the accepted top limit of
human potential because up until then, the fastest measured mile was four
minutes and 1.4 seconds.
Good thing Sir Roger Bannister didn’t get the memo.
On May 6th of that year, history was made when Bannister completed the mile
in three minutes and 59.4 seconds, breaking the world record and shattering the
myth that no human being could run faster than a four-minute mile. Even more
surprising was the fact that although Bannister had competed in the 1952
Helsinki Olympics, he had very little time to train for this world-record race as
he was also working as a junior doctor at the time. Still, he pulled it off . Was it
because he didn’t get the medal he wanted in Helsinki and was driven to
accomplish the “impossible” in order to redeem himself? Perhaps. Or was it
simply because he believed it could be done, and he was the man to do it?
Maybe.
Whatever gift or grace Bannister had working for him on that blustery day in
England, one thing is for sure—the myth of human limit was replaced with the
possibility of human potential. That Bannister shattered the myth of the fourminute mile being impossible to beat was proven just forty-six days later, when
Bannister’s rival John Landy broke his record, running the mile in three minutes
and 57.9 seconds.
In working Profit First in my own business and helping entrepreneurs do the
same with their own companies, I can tell you that the biggest hindrance to a
successful implementation of this powerful plug-in is our own perception of
limits. Even after we start working the Profit First system, we are vulnerable to
tired myths about what works and what doesn’t, what can be done and what can
never be achieved.
Profit First falls apart when we buy into accepted notions of how financials
“should” be managed:
“It takes money to make money.” “You’ll make money at the end.”
“If you want to make more money, you need to sell more.”
“You just need to follow the accepted accounting principles. It’s all there.”
That last one is tough for most entrepreneurs to refute, because we hire
bookkeepers, accountants and CPAs as experts. If they don’t agree with the
Profit First system, maybe we should go back to our old way of doing things.
Right?
Ah. . . nope.
The other day I got a call from Bob, an accountant affiliated with one of the
businesses I was hired to consult with (and, let it be noted, Bob is not a PFP). He
said, “You know, Mike, all of these bank accounts you set up, they’re a real pain
in the ass. Each one needs to be reconciled, and there are constant transfers
between them. All you need is one account. You can do all of these separate
accounts on your general ledger. I mean, for God’s sake, Mike—it is so easy to
be profitable. Just do the accounting and all of this other stuff is unnecessary.”
I blame my snarky response on a lack of sleep, because I don’t get ruffled too
often. I said, “Bob, you have about two hundred clients, right?”
“More like two-fifty.”
“Wow, two hundred and fifty clients,” I said. “And you do all of the accounting
for them and prepare the tax returns and the P&L (profit and loss), the cash flow
and balance sheets, right?”
“Yep. Of course, Mike.”
“And I suspect you tell them exactly what you told me,” I continued. “That they
just need to do the accounting and look at the statements and it’s all right there in
black and white?”
“Yes, absolutely. Where are you going with this?”
“I just want to know,” I replied, “what percentage of your clients are truly
profitable. I want to know how many of your clients have a true chunk of
accumulating cash sitting in their business at the end of each year. I would be
shocked if it was even twenty percent.”
Radio. Silence.
“Is it less? Is it ten percent?” I pressed.
Still no response from Bob, though I heard some heavy breathing on the other
end (not the fun kind).
“Are you saying that, just following the logic of accounting, less than five
percent of your clients are profitable year in and year out, Bob?”
Click.
“Bob, are you there? Earth to Spock. Earth to Spock. Are you there, Spock?”
If it all boiled down to conventional wisdom, you would be rich and every
business would be profitable—and we’d still be running four-minute miles.
The fastest way to screw up Profit First is to start sliding back into old belief
systems that got you into trouble in the first place. It’s easy to do. The relief of
finally getting a handle on our finances and watching our profit rise can cause us
to feel that our little cash flow problem is “fixed” and we can go back to using
old-fashioned accounting methods, focusing on the top line and dumping our
money in one account. We think, “I get this now. I don’t need to move money
around to all of these accounts. I don’t have to withdraw my profit first on every
deposit.”
That kind of thinking, my friend, is like starting down a slippery slope. I’m not
sure why you would choose that over the smooth path, but again I’ll just chalk it
up to being human.
In this chapter, I’ll share a few more pitfalls to avoid as you work the Profit First
system. Chief among them is the willingness to fall in line with conventional
thinking. Fight the urge! Since Bannister beat the four-minute mile, runners have
knocked seventeen seconds off that time. Seventeen seconds! Surely you can run
a profitable business—you won’t even have to break a sweat.
GOING TOO BIG, TOO FAST
It is extremely common for entrepreneurs new to Profit First to start putting 20%
or even 30% into their Profit Account right out of the gate. The next month they
realize they can’t afford it and pull the money back out to pay bills, which
defeats the entire process. You must allocate profit and not touch it, so you’ve
got to be sure that your business can handle the reduction in operating income.
To increase your profit, you need to become more efficient, to deliver the same
or better results at a lower cost. Profit First works from the end goal backwards.
Once upon a time, you used to try to get more efficient in order to turn a profit.
Now, by taking profit first, you must become efficient to support it. Same result,
reverse-engineered.
This is why I suggest you start with a small percentage. Don’t fall into the trap
of hogging all of the grub, taking too much profit up front and then shuffling
most of it back into your Operating Expenses Account when payroll comes due.
Start with a small percentage to build the habit. Every quarter, move your Profit
First allocation percentages closer to your goal by increasing them by an
additional one or two percent. Starting slowly will still force you to look for
ways to get better and more efficient at what you do, but you won’t be tempted
to throw in the towel on the entire system because the pressure is too great or the
task “impossible.”
Remember Jorge and Jose, the Profit First masters of the greater Miami area? At
one point, pumped at the results they had achieved with lower percentages, they
allocated 20% to their Profit Account and quickly realized their business could
not support both that much profit and the tremendous growth they were
experiencing. So, they adjusted the percentage until they achieved a balance with
their Profit Account allocation—high enough to make a real difference in their
rainy day and celebration funds, but low enough that it did not hinder growth.
Jorge and Jose adjusted the Profit Account percentages on a regular basis,
factoring in short-and long-term needs and delaying equipment purchases they
couldn’t swing. They did everything right—and have a successful, thriving
business to show for it.
“Too much of a good thing” is possible, even when it comes to watching your
Profit Account grow rapidly. Whether you make this mistake at the outset of
implementing the Profit First system or down the road when the future looks
especially rosy, be sure to correct it as soon as possible or you’ll find yourself
slipping back into the Survival Trap.
CUTTING THE WRONG COSTS
By now, you know I’m a renewed frugality junkie. I get a high from saving
money, and I get the biggest rush when I find a way to eliminate an expense
altogether. Still, not all expenses should be cut. We need to invest in assets, and I
define assets as things that bring more efficiency to your business by allowing
you to get more results at a lower cost per result. So, if an expense makes it
easier to get better results, keep it or purchase it.
I once toured the factory of a company that makes knives. When I noticed they
were using old tools, one of the owners said, “Yup. We even have systems from
the 1960s! We save so much money by keeping our old equipment.”
During my tour, I also noticed that the knives they produced were inconsistent in
terms of quality. Some of the knives were sharp; some were not. The handles
rarely had a snug fit. Coincidentally, I had toured a different knife company
earlier that week and noted that in one cumulative hour of manufacturing time
they were able to turn out one perfect knife after another at a volume four times
that of the company stuck in the decade of screaming Beatles fans and free love.
Money is made by efficiency—invest in it. If a purchase will bring up your
bottom line and create significant efficiency, find ways to get the same results
with different or discounted equipment (or resources, or services) rather than cut
the cost.
“PLOWING BACK” AND “REINVESTING”
We use fancy terms to justify taking money out of our different allocation
accounts to cover expenses. Two that are used most often are “plowback” and
“reinvest,” which are really just other ways to say, “borrow.” I have done this. I
“plowed back” money from my Profit Account to cover operating expenses, and
boy, do I regret it.
When you don’t have enough money in your Operating Expenses Account to
cover expenses, it is a big red flag that your expenses are too high and you need
to find a way to fix them fast. Once in a blue moon, it could also mean that you
are allocating too much to Owner’s Pay or Profit. This only happens when you
start with a high Profit or Owner’s Pay percentage. And when it happens, it is
because you are taking a percentage of profit or pay that you are not yet able to
sustain; the efficiencies are not yet in place to support your profitability. But
again, this is rarely the reason your Operating Expenses Account is in the red.
Likewise, some entrepreneurs continue to use their credit cards for day-to-day
operations and call them “lines of credit.” This is not accurate. It’s money you
don’t have. Your credit card bill is not an expense; it’s debt, plain and simple.
Using a credit card to cover what you can’t afford is also a red flag that your
expenses are too high. Stop using the credit card and reserve it for legitimate
emergencies or unique circumstances (like for a purchase you must make to
yield income).
RAIDING THE TAX ACCOUNT
In the first year or two of doing Profit First, you may get caught in a tax bind
because you only pay your estimates. For example, your accountant may prepare
estimates based on your business’s prior year’s income and profitability that say
you should make payments of $5000 every quarter.
As your Profit Account and Tax Account grow, you may be surprised to see that
you’re reserving about $8000 in taxes each quarter. Seeing this, you might think,
“Hey, my accountant said I should pay $5000 per quarter. I’m reserving too
much for taxes.” A little voice inside your head may even say, “Don’t touch that
money, you’ll probably need it for taxes.” And then a louder voice will say,
“Nah, don’t worry about it, you probably won’t owe it and even if you do, you
have time.” Cue the $3000 withdrawal to pay yourself, or pay bills. (A still
louder voice—one I’ve may have heard myself—might say: “Why not start
leasing a brand new sports car with that money? Not only is it a business
expense, you will instantly become the sexiest beast on this planet.” Do not
listen! Danger, Will Robinson! Danger!)
Big mistake.
As your profitability grows, your taxes will too. In fact, paying more taxes is an
indicator that your business health is improving. Now, I am not saying you
should ever pay more taxes than you need to (tax is just an expense like any
other), but do realize that your taxes will grow as your business health does. So
don’t steal from your Tax Account thinking you won’t need that money for
taxes. You will.
At times, you may even need more than you think. I messed up when I paid my
estimated taxes every quarter and then used the extra money to increase my
Owner’s Pay when I discovered there was money left over. Dummy! Tax
estimates are based on your prior year’s income. If you make more profit this
year (which you will), you will pay more taxes, but your tax estimates will not
change. If you spend “leftover” money from your Tax Account simply because
you allocate more than the estimate, you will be in shock come tax time.
Talk to your PFP every quarter to gauge how you are doing on taxes. And don’t
take money out of that Tax Account! Your business is growing by leaps and
bounds, and higher taxes are definitely in your future.
Another tax issue has to do with paying down debt. I call this “paying for your
sins,” because if you have debt you need to wipe out, implementing Profit First
is going to hurt in the beginning. I should know—it happened to me.
Here’s the problem: The government gives you a tax break on expenses but does
not consider the money you reserve to pay down debt an expense. The actual
charges on your credit card and the interest and credit card fees can be expensed,
but not your payments to pay down your cards.
I can’t believe I’m saying this, but in this case, the government is right. You get
the tax benefit in the year that you make the purchase— no matter if you paid for
the expense in cash, by credit card or with funds from a bank loan or line of
credit. As you become profitable and pay off debt, you will pay taxes on that
income. Eliminating debt and paying taxes will feel like a double whammy. It
isn’t—you just need to pay for your “sins.”
•••
My own business—and life—has turned around for the better because of Profit
First. I am eternally grateful for the financial stability and freedom it has given
me. But I also know how easy it is to fall off of the Profit First wagon. It’s
happened to me, and I’ve seen it happen to many businesses. Not only do people
fall off the wagon, it rolls all over them.
It’s easy to fall back into the old ways because they seem to make sense (they
don’t), or because our accountant says we shouldn’t bother (we should), or
because we think we were happier doing things the old way (we weren’t).
I’ll leave you with a quote from the great Sir Roger Bannister, who busted
through the myth that the four-minute mile could not be beat: “The man who can
drive himself further once the effort gets painful is the man who will win.”
Right-o, Sir Roger.
ACTION STEP
GET REAL WITH YOUR ACCOUNTANT
The Only Step: Sit down with your accountant, preferably a PFP trained in this
system, and come up with a game plan to ensure that you don’t end up allocating
too much revenue to your Profit Account and you do allocate enough to your
Tax Account. Schedule quarterly checkins to make sure you are consistently
building up your profit and other allocations while reducing your operating
expenses.
CHAPTER TWELVE: Financial Freedom Is Just a
Few Clicks Away
Life is better on the other side of the street. That’s not just a metaphor—I
literally live directly across from the house I lived in when my life fell apart due
to my own arrogance and belief in top line business principles. And let me tell
you, life is much, much better on this side. Not just because we’re living in a
house that we love. Not just because I took home and kept more salaried income
last year than I’ve ever earned in my life. Life is better because I am no longer a
slave to my monthly nut. The Frankenstein monster has become a beautiful
Clydesdale workhorse.
Running a Profit First business and lifestyle has given me complete confidence
over my finances and freed me from the endless search for a big payout. I’m no
longer looking for the Holy Grail—I don’t need it. My businesses are profitable
today, and they will continue to be profitable tomorrow, next month and in the
years to come. I am stringing together small financial win after small financial
win— every 10th and 25th of the month.
From my family room window, I can see my old driveway, my old yard, the
front door I entered that memorable Valentine’s Day when I faced the reality
that I’d lost everything. That day, after my daughter slid her piggy bank across
the dining room table to me, I stared at it for a few moments, stunned silent.
Though the piggy bank was in near-perfect condition, Adayla had secured the
bottom stopper with clear sticky tape, duct tape and rubber bands. That’s when I
remembered a lesson I had long forgotten.
I recalled an earlier conversation when I asked, “Angel, why do you have all that
tape over your piggy bank’s belly? That stopper works just fi ne.”
PROFIT FIRST
She had said, “I’m saving for my own horse, Daddy. Every Sunday when you
and Mommy give me my chore money, I run upstairs and put it in here. I don’t
want it ever coming out, until I have my horse.” That’s when it hit me: My nineyear- old daughter had a far better understanding of money management than I
did. It was the most humbling moment of my life.
I pushed the piggy bank back to her and said, “Honey, this is yours. We will be
fine. I will make sure of it. I will fix what I have broken. But thank you. Thank
you from the bottom of my heart.”
As low as I felt that day, my daughter’s selfless act gave me the courage to let go
of my tired ideology and not just recover from my financial problems, but fix
them permanently.
The normal response to fixing problems is to try to change our habits. In The
Power of Habit Charles Duhigg says habits are “click, whirr.” Triggered by
something (like an empty bank account)—click— we go into our reactionary
routine, like making panicky collection calls, for example—whirr. As Duhigg
points out in his book, changing habits is possible but is also really, really hard.
Instead, simple systems that capture the good parts of our habits and guard us
from the bad parts will bring about positive and permanent change, fast.
That’s all Profit First is—a simple system that works with us as we are. All you
have to do is follow it. You don’t have to get an MBA, or take an accounting
course, or start devouring articles in The Wall Street Journal. You don’t have to
change or “fix” who you are for this to work. It just does.
Why would I ask you to change who you are? You have been able to grow your
own, amazing business doing what you do, and that’s remarkable by any
measure. Now, all we need to do is capture your good money habits and put
guard rails up to protect you from your “humanness.”
It really is that simple. We are going to put profit first. Period. You don’t need a
miracle, or a lucky night in Vegas. You don’t need
a windfall, or a colossal client, or a worldwide phenomenon to realize the vision
you’ve held for your business since you opened your first box of business cards.
You simply need to put your profit first and everything else will fall into line.
My daughter, now fifteen, paid her way to Europe with that piggy bank money,
and she’s close to having enough to buy her horse. It’s not rocket science, and
you don’t have to have a truckload of karma to get it. Financial freedom really is
just a few small plates away.
Life is better on the other side of the street. Putting your profit first makes it
pretty easy to get there.
You know how, at the end of some movies, after the credits roll, there’s a little
bonus footage? Like in Ferris Bueller’s Day Off, when Ferris comes back on the
screen and says, “You’re still here? It’s over. Go home. Go.”
It’s like a little treat for everyone who stayed to watch the credits.
Your bonus for sticking it out, facing the music and slogging through heady
content is this:
If logic worked, everyone would be rich. It’s simple—spend less than you make.
But you’ve always known that, and now you know that logic alone doesn’t
work. Leveraging your emotions and behavior is the most powerful profitmaking tool. Profit first. Always.
You’re still here? It’s over. Go make some money. Go!
ADDITIONAL BOOKS BY MIKE MICHALOWICZ
Table of Contents
Title page
PRAISE FOR MIKE MICHALOWICZ
TABLE OF CONTENTS
ACKNOWLEDGMENTS
INTRODUCTION
CHAPTER ONE: Taming The Beast
CHAPTER TWO: How Profit First Works
CHAPTER THREE: The Naked Truth
CHAPTER FOUR: Choose Your Own Adventure
CHAPTER FIVE: Day One, Quarter One, Year One and Forever
CHAPTER SIX: Destroying Debt
CHAPTER SEVEN: Found Money
CHAPTER EIGHT: Sticking With It
CHAPTER NINE: Profit First - Advanced Techniques
CHAPTER TEN: Living Profit First
CHAPTER ELEVEN: Where It All Falls Apart
CHAPTER TWELVE: Financial Freedom Is Just a Few Clicks Away
ADDITIONAL BOOKS BY MIKE MICHALOWICZ